Placing Forex Trades With A Stochastic Oscillator
The stochastic oscillator is in a category of technical indicators called momentum indicators
, which measure the velocity of price changes instead of the actual trend or price levels themselves. Since this indicator measures price velocity and does not care about actual price levels, it works as a great predictive indicator that can indicate overbought or oversold market conditions which can warn a trader that the price is vulnerable to a short-term change in direction.
One of the most popular momentum indicators that is included in nearly every charting package is called the Relative Strength Index, which gauges price velocity on a scale of 0-100 with 50 as the center line, where market conditions below 20 indicate oversold and market conditions over 80 indicate overbought. This is very valuable information to a trader for two reasons: First, a change in the velocity of price movement will tend to occur before a change in price levels, so the indicator can yield signals that are predictive and not retrospective in nature. Second, it is the buying or selling pressure of bulls and bears that creates up and down movements in the price, but once a price move reaches its zenith and there is no more momentum or market pressure to keep the market moving, this is the signal for a market reversal and the momentum indicator will precede this reversal.
Looking at a stochastic oscillator can be more insightful in some ways than just the typical RSI momentum indicator because there is more information conveyed on the indicator itself. It uses a typical 0-100 scale with the same overbought and oversold parameters as the RSI, but on the stochastic oscillator there are two lines related to the velocity of price data instead of just one. There is a faster moving line on the indicator which is the actual stochastic level that measures momentum, and then there is the slower moving line which is a moving average of the original momentum levels that can act as your signal line just like a moving average on the price chart will do.
When the stochastic line crosses the moving average line from the bottom going up, this is the signal to buy; when the stochastic line crosses the moving average line from the top going down then this is the signal to sell. These signals are particularly valid when a buy signal is given in oversold territory and a sell signal is given in overbought territory, because this is your indication of a short-term reversal in price which will be given before the actual price movement, meaning that you can get in the market at the right time and make sure that your sell price is higher than your buy price.
by: Ricky Weber
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