Monday, July 28, 2014

Forex Stochastic Indicator Explained

June 2, 2010 by  
Filed under Fx Indicator


The stochastic indicator is a tool that is developed by George C.Lane. It is in fact a momentum indicator or oscillator that is used to compare the current market price to the high and low of a specific period of time.

The stochastic is made up of 2 lines, %K and %D. Depending on your setting, you can adjust the sensitivity of these 2 lines to suit your plan.

Although 4here are 3 types of stochastic namely full, fast and slow, the fast and slow ones are more commonly used. So let us take a look at both of them.

From the picture above, you can see that there are more crossovers for the fast stochastic which means that it is actually more sensitive than the slower one. However this gives rise to more false signal which is undesirable in trading.

As for the slow stochastic, it is less sensitive and produces lesser false signals as compa2ed to the fast one. Due to its low sensitivity, it will usually signal you to enter a trade after the market has already moved by certain amount.

How to Read the Stochastic?

When the stochastic moves above the 80 level, the market is considered to be overbought and when it moves below the 20 level, the market is considered to be oversold.

However there is one thing you have to take note, when it moves above the 80 level, it does not always mean that the market will reverse. There are times where it will continue to stay above the 80 level and in this situation; it usually indicates that the market is in a strong uptrend.

overbought and oversold

The important thing to note when reading the stochastic is when the %K crosses above %D after it reaches the oversold level or when the %K crosses below %D after it reaches the overbought level.

How to Use the Stochastic?

There are several ways you can use the stochastic to help you in your trading and below are some of them

1) Entry Signal: It can be a great tool when it comes to giving entry signal. Personally I like to enter my position when the %K crosses the %D and move out of either the overbought or oversold level.

If I am looking to go LONG, I will wait for the stochastic %K to cross above the %D and move above the 20 mark. If I am looking for a SHORT trade, I will wait for the %K to cross below the %D and move below the 80 mark.

2) Exit Signal: The concept for using stochastic to exit my position is about the same as the entry. If I have taken a LONG trade, I will wait for it to move to the overbought zone and exit my position after %K crosses below %D and move below the 80 mark.

Exit Signal

3) Reversal Signal: Other than MACD divergence, you can also make use of stochastic divergence to enter a trade. The positive divergence occurs when the market makes lower low while the stochastic make higher low. This is usually an indication that the market is going to reverse up.

Positive Divergence

The negative divergence occurs when the market makes higher high and the stochastic make lower high. This usually signifies a downward reversal is going to occur.

Negative Divergence

The above are 3 ways I usually use the stochastic and I hope that you will be able to make full use of its ability to help you in your trading.

If you want to find out more about how I trade with modified stochastic indicator below.

 

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Comments

32 Responses to “Forex Stochastic Indicator Explained”
  1. shahriar says:

    Hi Calvin,

    I appreciate it if you recommend me that which Stochastic is good to use as slow one and fast one. I mean please tell me the exact D%,K% and slowing for both fast and slow stochastic which you use.

    Thanks,

    • Kelvin says:

      Hi Shahriar

      For the slow Stochastic, you can set the %K to 5, %D Slowing Periods as 3 and %D as 3.

      For the fast Stochastic, you can set the %K to 5, %D Slowing Periods as 3 and %D as 5.

  2. Luke Dixon says:

    Hi Kevin,I am confused about when and which pivot point levels to use where.Let me give an example: Supposing I am using the hourly chart and, already have computed the pivot levels for the day chart.For example can I use the daily levels on the hourly chart? Your understanding will be welcome.
    Bye for now Luke

  3. Robby says:

    Thanks Kelvin for the lesson. Learn to trade with momentum with only a macd and 50 sma with Price Action and you will have an edge.The charts you just illustrated had 2 winners going up trading . You had 2 entries on engulfing candles and the stochastics were overbought. Not trying to sound like a smarty but trading tops and bottoms as you illustrate is really risky.If you woud like to know more e-mail me.

  4. harbans says:

    Thanks for explaining the stochastic. Could you please suggest which time frame it gives good results and should it be simple or exponential.

    Thanks dear

    • Kelvin says:

      Hi Harbans

      The stochastic itself works in all time frames and it is more responsive if you set it to exponential.

  5. wisner says:

    what’s fast Stochastic and slow Stochastic?the default setting is 5,3,3

    • Kelvin says:

      Hi Wisner

      The slow stochastic are less responsive but I find it better as it has lesser noise. However it depends on the broker you are using. I understand that some brokers only provide stochastic oscillator and there is no slow or fast one.

  6. Rahul says:

    Hi Kelvin

    Really Good work!!!! I appreciate you. Graphs and theory is quite benifited for
    newbies to understand the complex indicators as easy as ABC.

    All the best!!
    Rahul.

  7. Ben says:

    Thanks Kelvin

    This helps alot.. I have been working with these 2 indicators for some time.

    Soon, I hope to be profitable.

    Ben

  8. Amar Rashid says:

    hi Kelvin,
    i always look forward to receive your emails and this is my first comment cum questions.

    i have created a stretgy and i would highly appreciate if you please review it and advise me in light of your experience if it is ok or if you suggest some changes.

    stochastic slow
    RSI
    Parabolic SAR
    Fast ema 7
    slow ema 11

    entry short/long
    1. stochastic should have crossed 2o /8o line and coming down / going up
    2. RSI should have crossed 5o line down / up
    3. Parabolic Sar should be up / down
    4. Fast ema should have crossed down / up and have minimum difference between both lines of 4 pips

    5. check the trend on 4 hours chart and entry on 15 min chart only in the direction of the trend of 4 hours.

    Exit. money management

    please review this stretgy coz after useing many stretgies and blowing many accounts i created this stretgy but still not confident enough to go live.

    please suggest also exit stretgy.

    and is it ok if i go against the trend of 4 hour chart if at 15 min chart stochastic change the direction alongwith other indicators or in other words if i only follow the trend of 15 min chart.

    many thanks for your answer.

    regards,
    Amar

  9. muhammed yakubu says:

    THANKS KEVIN. This is a wonderful and educative lesson very resouceful I pray to see more of that and one day I will be a profitable trader.

  10. bmb says:

    Thank you Kelvin. Its best for me. good luck for your life.please explain stochastic smile?

  11. sunny iwuji says:

    thank this is great. but what the parameter of setting the stochastic oscillator for %k and %d or do i stay with the default settings

  12. Sheena says:

    Hi Kelvin,

    I was juz surfing and landed to ur page…it seems that u’ve great way of explaining quite details on the indicators. Its true that its hard to get a person whom can spend time sharing his forex knowledge coz most of my friends are stingy of their forex knowledge. So I would say,millions thanks to u as I’ve found what I need to know more about the indicators as a newbie in forex trading.

    But I’ve a question for u…as u said its good to have few indicators as to get more accurate signal (I can say)…so what are the good combination of indicator would u suggest? And to apply it to the graph, which time would it best show good signals…or at least a clear signal? Personally,I only rely on H1 and M1(juz to get the best entry level),and sometimes I look for H4…is it ok?

    Thanx in advance….

    • Kelvin says:

      Hi Sheena

      There is no best combination as different strategy needs different combination and there is no one size fits all combination.

      I think that the best time frame for new traders will be the 15 and 5 minutes chart. The 1 minutes is too confusing as there are a lot of movement going on. If you are using the hourly and 4 hour, I will recommend you to use the 15 minutes instead of 1 minute.

  13. denny says:

    hello kelvin…

    i am trading a swing trade in forex by using stochastic…take profit 50 point…

    when the trend in H4 is uptrend, i will be wait until the stochastic H4 cross up, H1 cross up, M30 cross up, and the last one is M15 cross up…

    how about it?

    • Kelvin says:

      Hi Denny

      This is what I usually call the top down analysis and this is a great way to increase your winning probability.

  14. fahmie says:

    hi kelvin,

    Thanks a lot for sharing your knowledge, its not easy to find people who share knowledge on forex…thanks again…its valuable for me…i’m still new in forex trading an i found that this website are valuable for me.

    Just want to ask 2 question:
    can i use this indicator for scalping technique? and if im using 15min as a time frame what is the best parameters to use…i’m still confuse in setting the parameters. can u advice the best parameters to use…

    • Kelvin says:

      Hi Fahmie

      Thanks for coming to this site and I am glad to hear from you.

      As for your question, you definitely can make use of the Stochastic indicator to scalp the forex market.

      Basically you can stick to the original setting by your broker but if you want to adjust the sensitivity, you can just do some adjustment and then see if it works better for you or not. There is no best parameter to use as it all depends on your trading style. If you set the indicator to be too sensitive, it will produce more false alarm which will in turn make you more losses than profit. If you set it less sensitive, it will produce lesser trading opportunity but at the same time lesser false alarm.

      I hope that I have answered your question and do let me know if you have any doubts.

  15. Rockdrop says:

    Dear Kelvin,

    I think you should make a forum for your site. It would probably increase more regular visitor interaction. So far your site is the most useful site I’ve encountered teaching how to effectively trade forex.

    • Kelvin says:

      I have consider this option before but it will too tough for me to handle forum reply, emails and comments at the same time. Maybe when this community grows big and i can get some help from you guys to run the forum together with me.

  16. dan says:

    hi…what is the best stochastic slow end fast for h4?or for h1.thanks.

    • Kelvin says:

      Hi Dan

      I personally like the slow stochastic as it produces lesser false signals compared to the faster one. However it also gives you lesser trading opportunity as compared to the fast stochastic.

  17. dan says:

    thank you.

  18. dan says:

    hi..one question to you….how you know when the price go long or go short?..because many of time stochastic make a x cross but the price remain overbought or oversell many of time .i think this oscilator is thery lagging indicator and dont tell you the future price.sorry about my english..

    • Kelvin says:

      Hi Dan

      Glad to hear from you again :)

      Regarding your question on the timing to go long or short, I usually go long after the %K of the stochastic crosses above the %D and move above the 20 level. If it is still below the 20 level, there is a high chance that the market may continue to move down due to strong trend.

      If you find the crossover in stochastic to be too frequent, you can adjust the sensitivity according to your needs. One thing to note is never to trade using simply one indicator, try to have a combination of a few indicators and only enter a trade when you get a confluence of event of most of them.

      I hope I have answered your question and do feel free to contact me if you have any problem.

      All the best to your trading!

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