A:

The stochastic oscillator is a momentum indicator that is widely used in forex trading to pinpoint potential trend reversals. This indicator measures momentum by comparing closing price to the trading range over a given period.

The charted stochastic oscillator actually consists of two lines: the indicator itself is represented by %K, and a signal line reflecting the three-day simple moving average (SMA) of %K, which is called %D. When these two lines intersect, it signals that a trend shift may be approaching. In a chart displaying a pronounced bullish trend, for example, a downward cross through the signal line indicates that the most recent closing price is closer to the lowest low of the look-back period than it has been in the previous three sessions. After sustained upward price action, a sudden drop to the lower end of the trading range may signify that bulls are losing steam.

Like other range-bound momentum oscillators, such as the relative strength index (RSI) and Williams %R, the stochastic oscillator is also useful for determining overbought or oversold conditions. Ranging from 0 to 100, the stochastic oscillator reflects overbought conditions with readings over 80 and oversold conditions with readings under 20. Crossovers that occur in these outer ranges are considered particularly strong signals. Many traders ignore crossover signals that do not occur at these extremes.

When creating trade strategy based on the stochastic oscillator in the forex market, look for a currency pair that displays a pronounced and lengthy bullish trend. The ideal currency pair has already spent some time in overbought territory, with price nearing a previous area of resistance. Look for waning volume as an additional indicator of bullish exhaustion. Once the stochastic oscillator crosses down through the signal line, watch for price to follow suit. Though these combined signals are a strong indicator of impending reversal, wait for price to confirm the downturn before entry – momentum oscillators are known to throw false signals from time to time.

Combining this setup with candlestick charting techniques can further enhance your strategy and provide clear entry and exit signals.

RELATED FAQS
  1. How do I read and interpret an Stochastic Oscillator?

    Understand the basics of the stochastic oscillator and how analysts and traders use this measure of trend momentum to predicts ... Read Answer >>
  2. What's the difference between relative strength index (RSI) and stochastic oscillator?

    Learn about some of the main differences between the relative strength index and the stochastic oscillator, two well-known ... Read Answer >>
  3. How do I create a trading strategy with Bollinger Bands® and the stochastic oscillator?

    Learn how to create a trading strategy by combining two different technical indicators, Bollinger Bands and the stochastic ... Read Answer >>
  4. What is the difference between fast and slow stochastics in technical analysis?

    The main difference between fast stochastics and slow stochastics can be summed up in one word: sensitivity. Read Answer >>
  5. What are the best indicators to identify overbought and oversold stocks?

    The relative strength index (RSI) and stochastics are two of the most popular indicators of overbought or oversold conditions ... Read Answer >>
  6. What are the main differences between Williams %R oscillator & The Relative Strength ...

    Learn about the Williams %R indicator and how this momentum oscillator differs from the relative strength index (RSI) both ... Read Answer >>
Related Articles
  1. Trading

    Best technical indicators to pair with the stochastic oscillator

    Learn how the stochastic oscillator indicator is sensitive to price, and discover technical indicators traders use to complement it such as the RSI and MACD.
  2. Trading

    Know the Forces at Play Behind the Buy/Sell Cycles

    Weekly stochastics uncover patterns of buying and selling that can be predicted and capitalized on.
  3. Trading

    MACD And Stochastic: A Double-Cross Strategy

    The stochastic oscillator and the moving average convergence divergence (MACD) are two indicators that work well together.
  4. Trading

    MACD and Stochastic: A Double-Cross Strategy

    Two indicators are usually better than one. Find out how pairing the stochastic and MACD can enhance your trading, and reveal entry points.
  5. Trading

    Percentage Price Oscillator – An 'Elegant Indicator'

    The percentage price oscillator, which measures momentum, is among the more sophisticated tools in the technical analysis arsenal.
  6. Trading

    Three Stocks Headed Into Long-term Buy Cycles

    These beaten-down S&P 500 components are finishing up long-term sell cycles that should yield strong multi-month bounces.
  7. Trading

    4 Double-Cross Buy Signs

    Will the double crossover on MACD and Stochastic indicators trigger a move higher?
RELATED TERMS
  1. Stochastic Oscillator

    A stochastic oscillator is a technical momentum indicator that ...
  2. Oscillator

    An oscillator is a technical analysis tool that is banded between ...
  3. Signal Line

    Signal lines are used in technical indicators, especially oscillators, ...
  4. Ultimate Oscillator

    The Ultimate Oscillator is a technical indicator that was developed ...
  5. Detrended Price Oscillator (DPO)

    A detrended price oscillator is an oscillator that strips out ...
  6. Chande Momentum Oscillator

    The Chande momentum oscillator is a technical momentum indicator ...
Trading Center