Trading with Stochastic indicator involves the following signals:
Stochastic lines cross — indicates trend change.
Stochastic readings above 80 level — currency pair is overbought,
Stochastic staying above 80 level — uptrend is running strong.
Stochastic exiting 80 level downwards — expect a correction down or beginning of a downtrend.
Same for readings below 20 level — currency pair is oversold,
staying below 20 — doentrend is running strong,
exiting upwards above 20 — expect an upward correction or a beginning of an uptrend.
The idea behind Stochastic indicator
The main idea behind Stochastic indicator according to its developer, George Lane, lies in the fact that rising price tends to close near its previous highs, and falling price tends to close near its previous lows.
How to interpret Stochastic indicator
Stochastic is a momentum oscillator, which consists of two lines: %K - fast line, and %D - slow line. Stochastic is plotted on the scale between 1 and 100.
There are also so called "trigger levels" that are added to the Stochastic chart at 20 and 80 levels. Those lines suggest when the market is oversold or overbought once Stochastic lines pass over them.
How to trade with Stochastic indicator
Let’s look at three methods of trading with Stochastic indicator.
Method 1. Trading Stochastic lines crossover
This is the simplest and common method of reading signals from Stochastic lines as they cross each other. Stochastic %K and %D line work similar to moving averages and:
when %K line from above crosses %D line downwards traders open Sell orders.
when %K line from below crosses %D line upwards traders open Buy orders.
Stochastic lines crossovers that happen above 80% level and below 20% level are treated as strongest signals, compare to crossovers outside those levels.
Traders may choose sensitivity of their Stochastics. The smaller the Stochastic parameters, the faster it will react to market changes, the more crossovers will be shown.
Sensitive Stochastic (for example 5, 3, 3) is useful for observing rapidly changing market trends. But because it is too choppy it should be traded in combination with other indicators to filter out Stochastic signals.
Method 2. Trading Stochastic oversold/overbought zones
Stochastic by default has 80% level, above which market is treated as overbought, and 20% level, below which market is considered oversold.
It is important to remember that while in sideways moving market a single Stochastic lines crossover that occur above 80% or below 20% will most of the time result in a fast predictable trend change, in trending market could mean just nothing. When price is trending well, Stochastic lines may easily remain in overbought/oversold zone for a long period of time while crossing there multiple times.
That’s why a method of trading overbought/oversold zones stands up. The rules here are to wait until Stochastic lines after being in overbought/oversold zone come out from it. E.g. When stochastic was trading for some time in overbought zone – above 80% level, traders wait for the lines to slide down and eventually cross 80% level downwards before considering to take Short positions. Opposite for Long positions: wait till Stochastic lines come into the oversold zone (below 20% level); wait further until Stochastic lines eventually cross 20% level upwards; initiate a buy order once Stochastic lines are firmly set, e.g. a trading bar is closed and Stochastic lines cross over 20% mark is fixed.
Method 3. Trading Stochastic divergence
Traders are looking for a divergence between Stochastic and the price itself. At times when the price is making new lows while Stochastic produces higher lows creates dissonance in the picture. It is called divergence. Divergence between price and Stochastic readings suggest a forming weakness of a main trend and therefore its possible correction.
Full versus Fast versus Slow stochastic
Full Stochastic inidcator has 3 parameters, like: Full Stoch (14, 3, 3), where the first and the last parameters are identical to those found in Fast and Slow Stochastic:
the first parameter is used to calculate %K line, while the last parameter represents the number of periods to define %D - signaling line.
The difference between Full and other Stochastics lies in the second parameter, which is made to add smoothing qualities for %K line. Applying this smoothing factor allows Full Stochastic be a bit more flexible for chart analysis.
Stochastic indicators formulas
Full Stochastic Formula
Fast Stochastic Formula
Slow Stochastic Formula
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CCI_NUF_v5 is another one version of the oscillator based on CCI indicator. Trading is made when the levels or nil are crossed. Moreover, we draw your attention on the levels +-200, which are overbought and oversold zones. Exit from them is a good signal. The indicator do not draw. CCI_NUF_v5 usage example
Developed by Wilder, ATR gives Forex traders a feel of what the historical volatility was in order to prepare for trading in the actual market. Forex currency pairs that get lower ATR readings suggest lower market volatility, while currency pairs with higher ATR indicator readings require appropriate trading adjustments according to higher volatility. Wilder used the Moving average to smooth out the ATR indicator readings,so that ATR looks the way we know it: How to read ATR indicator During more volatile markets ATR moves up, during less volatile market ATR moves down.When price bars are short, means there was little ground covered from high to low during the day, then Forex traders will see ATR indicator moving lower. If price bars begin to grow and become larger, representing a larger true range, ATR indicator line will rise. ATR indicator doesn't show a trend or a trend duration. How to trade with Average True Range (ATR) ATR standard settings - 14. Wilder used daily charts and 14-day ATR to explain the concept of Average Trading Range. The ATR (Average True Range) indicator helps to determine the average size of the daily trading range. In other words, it tells how volatile is the market and how much does it move from one point to another during the trading day. ATR is not a leading indicator, means it does not send signals about market direction or duration, but it gauges one of the most important market parameter - price volatility. Forex Traders use Average True Range indicator to determine the best position for their trading Stop orders - such stops that with a help of ATR would correspond to the most actual market volatility. When the market is volatile, traders look for wider stops in order to avoid being stopped out of the trading by some random market noise. When the volatility is low, there is no reason to set wide stops; traders then focus on tighter stops in order to have better protections for their trading positions and accumulated profits. Let's take an example:EUR/USD and GBP/JPY pair. Question is: would you put the same distance Stop for both pairs? Probably not. It wouldn't be the best choice if you opt to risk 2% of the account in both cases. Why? EUR/USD moves on average 120 pips a day while GBP/JPY makes 250-300 pips daily. Equal distance stops for both pairs just won't make sense. How to set stops with Average True Range (ATR) indicator Look at ATR values and set stops from 2 to 4 time ATR value. Let's look at the screen shot below. 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ATR for trailing stops Another common approach to using ATR indicator is ATR based trailing stops, also known as volatility stops. Here 30%, 50% or higher ATR value can be used. Using the same range of 110 pips for EURUSD, if we choose to set 50% ATR trailing stop, it’ll be placed behind the price at the distance of: 110 x 50% = 55 pips. ATR based indicators for MT4 Due to high popularity of the ATR volatility stops study, traders quickly put the theory to practice by creating customized Forex indicators for Metatrader 4 Forex platform: VoltyChannel_Stop ChandelierExit