
What is also important aside from finding the beginning of a trend? It is finding the end of the trend! Today, we will tackle a technical indicator that does the job, and we call it the stochastic oscillator.
What is a stochastic oscillator?
In the late 1950s, George Lane created the stochastic oscillator, a technical indicator that helps us find where the trend will end. It has a theory saying that:
- The prices will be the same, and if not, they will be above the previous price when an uptrend is happening.
- The prices will remain the same, and if not, they will be lower than the price when a downtrend occurs.
The stochastics are measurement tools for the momentum of the price. We can apply this thought even in our daily lives. For example, when we jump, we need to bend down a little first to jump higher. If we think about big things like rocket science, a rocket must slow down first before it goes higher and higher in the air. Momentum will always change direction prior to the price.
How does a stochastic oscillator work?
Stochastic oscillators have a scale to measure degrees of changes between prices coming from a closing period. It is to have a clue or an idea about the current direction trend’s continuation. If you are aware of what MACD lines are and what they do, you can argue that they have a few similarities. How? Stochastic oscillators also have two lines to compare to MACD lines where one is faster, and the other is a slower one.
Forex trading with a stochastic indicator
If there is one thing that we can tell you about the stochastic indicator, it is the fact that it can also let us know when the market is in a state of overbought or oversold. We mentioned a while ago that this indicator uses a scale. This scale ranges from 0 to 100.
The market may be overbought when the stochastic lines are above 80. It is a red dotted line in the chart above. It is possible that the market is overbought when the stochastic lines are lower than 20. If we look at the chart, this looks like a blue dotted line. Trading decisions should indeed have a solid basis. However, based on many people’s experiences, it might be a good move to buy in an oversold market and sell when there is a possibility that the market is overbought. Most of the time, when the market is overbought for an extended period already, then there is a huge possibility that a reversal may happen.
Let us summarize!
A stochastic oscillator is simple. It is an indicator that lets us know where the market can become possibly overbought or oversold. The stochastic oscillator can also be above 80 or lower than 20 for a long time but always be wise in your trading decisions. We always stress that the market is “possibly” overbought, and you should be careful in selling since, again, it is just a possibility. This advice is also applicable in oversold situations.
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March 14, 2018
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