Trading Using the Stochastic Indicator
The Stochastic is one of the most popular indicators for trading any financial market. It oscillates between two extreme values (0 and 100). The indicator evaluates the momentum of a price trend and can also identify divergences.
Stochastic can generate various types of trading signals, including entry, exit, trend reversals, and support and resistance levels. The most reliable signals occur across multiple timeframes rather than within a single timeframe. For greater reliability, Stochastic readings should be combined with and confirmed by another technical analysis tool, such as Fibonacci retracement.
📈 Trading with Stochastics at a Glance
The Stochastic Oscillator measures a currency pair's closing price relative to its price range over a specified period—typically 14 days. It generates two lines, %K and %D, which oscillate between 0 and 100. This indicator helps identify overbought conditions (above 80) and oversold conditions (below 20), signals momentum shifts through line crossovers, and highlights potential reversals by spotting divergences between price action and the oscillator.
■ The Stochastic can be used in any market, but it is most effective when trading major Forex currencies, especially EURUSD and GBPUSD.
■ On a 5-minute timeframe, you typically get 2–4 trades per day.
■ The Stochastic indicator can be combined with Fibonacci Retracement, Bollinger Bands, RSI, Moving Averages, and the Directional Movement Index for more reliable signals.
■ The standard Stochastic settings are (14,3,3), but for short-term Forex trading, use settings of (5,3,3).
■ The two key Stochastic levels are 80 (indicating overbought conditions) and 20 (indicating oversold conditions).
⛭ The Stochastics Formula
This is the Stochastic Indicator formula:
■ %K = {(Last Price - Lowest Low in K period)/(Highest High in K period - Lowest Low in K period)} X 100
■ K represents the number of periods.
■ The standard Stochastic settings (14,3,3)
♞ The Stochastics Indicator Trading Strategy
This is how the Stochastic trading strategy can be applied when trading.
Signaling the Trade
These are the two general Stochastic trading signals:
■ (↑) Signals for Long Trades (buy)
When Stochastic is below 20 and the Stochastic MA crosses upward, this is a general signal of an upcoming bullish market and we should go long.
■ (↓) Signals for Short Trades (sell)
When Stochastic is above 80 and the Stochastic MA crosses downward, this is a general signal of an upcoming bearish market and we should go short.
■ To achieve the best entry or exit, the Stochastic should be combined with another indicator, as explained below.
Long-term Stochastic signals can be traded with weekly and monthly expiries. Mid-term signals can be traded on weekly and daily timeframes, while short-term Stochastic signals can be traded intraday.
The Stochastic Triple-Cross Signals
Stochastic triple-cross signals occur when a trading signal (up or down) is confirmed across three timeframes simultaneously (long-term, mid-term, and short-term). These triple-confirmed signals carry greater strength and can be used effectively for Range and Boundary options, as well as Up & Down options.
Combining the Stochastics with Basic Price Action
Relying solely on Stochastic readings can lead to losses. Stochastic signals must always be confirmed by another indicator or by analyzing price action. Here is how to confirm Stochastic using basic price action:
■ Confirming a Bullish Signal
Suppose the Stochastic is below 20 and the Stochastic MA crosses upward, forming a general bullish signal. Wait until the asset price fails to form a new low. This means a new local high is higher than the previous high, and the recent low is higher than the previous low.
■ Confirming a Bearish Signal
Suppose the Stochastic is above 80 and the Stochastic MA crosses downward, forming a general bearish signal. Wait until the asset price fails to form a new high. This means a new local low is lower than the previous low, and the recent high is lower than the previous high.
Combining Stochastic with Fibonacci Levels – How to Make Stochastic Trading Signals More Accurate
To achieve more accurate signals, the Stochastic can be combined with Fibonacci levels.
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Apply the Fibonacci levels using the Fibonacci Retracement tool. Mark two points: the narrowest crucial support and the narrowest crucial resistance to apply the retracement correctly. The three main Fibonacci levels are:
■ 38.2%
■ 50.0%
■ 61.8%
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Then, wait for signals from the Stochastic Oscillator and confirm them using the corresponding Fibonacci levels.
Example: Combining Stochastic with Fibonacci in a Downtrend
Suppose the price of an asset is moving in a downtrend and the Stochastic is below 20. Suddenly, the price starts moving upward and the Stochastic rises above 20, indicating a potential price reversal. This potential reversal can be confirmed using the three major Fibonacci levels. If the asset’s price also reaches a significant Fibonacci level, a strong reversal is likely, and the trading signal is generally confirmed. Confirmation means that a trade can now be executed in the opposite direction (a bullish trade). See the following example (buy signal).
Combining the Stochastic with Other Technical Analysis Indicators
Stochastic readings can be combined with many other technical analysis tools, such as moving averages (34, 50, 100, or 200 periods), depending on the timeframe used. It can also be combined with indicators like ADX, RSI, or Bollinger Bands. However, avoid combining Stochastic with more than one additional indicator, as this can make your system overly complex and too slow to execute, especially in short-term trading.
■ Trading Using the Stochastic
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» Introduction to Trading Strategies
♞ DAY-TRADE STRATEGIES
» Falsebreak Candle
» Bollinger-RSI
» Stochastic Day-Trade
» Breakout Strategy
♚ SWING-TRADE STRATEGIES
» Riding the Trend
» Moving Envelopes
» MACD Swing
♜ SCALPING STRATEGIES
» Stochastic Scalper
» Bollinger-RSI Scalping
» Hit-Run Trading
♟ STRATEGIES FOR BEGINNERS
» News-Trading
» Follow-The-Trend
» Support and Resistance
» Fibonacci Retracements
» Stochastics Trading
» Chart Patterns
💱 MARKET CORRELATIONS
» US Yields and USDCHF
» Crude Oil and Forex
» USDJPY and US Stock Indices
» AUD and Gold Price Correlation
