What is a Stochastic Indicator?
The Stochastic indicator is another oversold/overbought indicator. George Lane developed the forex Stochastic indicator in the early sixties. The idea behind stochastic indication is that it assumes that when the price goes up it is often closes near the top end of the recent price range. On the other hand, when the price goes down it often closes near the lower end of the most recent price range.
How does the Stochastic indicator work?
The Stochastic can be described as a momentum type oscillator that moves or oscillates between the numbers zero and hundred and comprises of 2 lines.
%K: is the main line that is referred to as the fast line, and is displayed as a solid line in the picture.
%D: This line referred to as the slow line, and is displayed as the dotted line.
The MetaTrader platform Stochastic indicator have 5 parameters that is used in its calculation, as you can see below:
%K Periods: this is the amount of periods (or bars) used to calculate the Stochastic indicator.
%K Slowing Periods: this indicates the %K line’s smoothing rate.
%D Periods: this indicates the amount of periods used for figuring out %K’s moving average, which gives the %D line.
Price field: this indicates the type of price used for figuring out %K’s moving average that can either be: High / Low or Close / Close.
MA method: this is a method of calculating the %K line’s moving average, either Exponential, Weighted, Smoothed, or Simple.
There are 3 ways to determine Stochastic indication:
1. Crossover: We can treat the stochastic indicator’s %K line and the %D line like 2 moving averages indicators, 1 of them being fast and the other being slow, and sometimes playing the crossover game. We purchase when the %K crosses down up %D. And we sell when %K crosses above down %D. Please note that the crossover of the forex stochastic indicator line sometimes gives choppy signals, which means that it needs to be filtered with other indictor/s.
2. Overbought / Oversold: When 1 of the stochastic indicator lines crosses the twenty and eighty percent levels it means it was an Oversold or Overbought market mood. We purchase when the stochastic indication falls below twenty percent level then rises above it. We the sell when the stochastic indication rises above eighty percent level then falls below it.
3. Divergences: Divergences between the forex stochastic indicator lines and a price is a great signal for selling and buying security. For instance, if purchasing prices are achieving a series of fresh highs and the stochastic indicator is trending lower, it may be a warning that signals some type of market weakness.