How to Use Stochastic to Improve Your Trades

A lot of traders underestimate the effectiveness and simplicity of swing trading using the stochastic oscillator. Stochastic is one of the best indicators to determine when a currency is either overbought or oversold. By using this indicator, you can determine when a trend is about to reverse and take advantage of that swing to the…

A lot of traders underestimate the effectiveness and simplicity of swing trading using the stochastic oscillator. Stochastic is one of the best indicators to determine when a currency is either overbought or oversold. By using this indicator, you can determine when a trend is about to reverse and take advantage of that swing to the opposite direction.

This is how this strategy works:

As discussed before, we are simply taking advantage of reversals of a trend so, when the treaties are overbought, we sell or go short and, the opposite is true when a currency is oversold where we would buy or go long.

The stochastic oscillator is the perfect indicator for this type of strategy, but, before we get into the strategy itself, let's get the technical explanation out of the way. No worries, this is a visual indicator and you do not really need to fully understand the formula. The formula is provided so that you know how the “engine” that drives this oscillator works.

The assumption for this technical indicator is that as a currency nears the 100 percent moving average a reversal to drive the price downwards is about to occurrence. The same is true as the price gets closer to the 0 percent moving average where a reversal will drive the price up.

The indicator is plotted as follows:

This oscillator is made out of 2 lines, the slow line which is the% D and the fast line which is the% K.

Since it is slower, the% D line is less sensitive than the% K line.

The% D line is a moving average of% K.

The trade signal is given by the% D line.

These lines are drawn on your chart ranging from 0 at the bottom of your chart to 100 at the top of your chart indicating the absolute highest and absolute lowest points a currency can get. Within those two lines, you will find a line at 80% and a line at the 20% marks. When the price goes above the 80%, it is assumed to be overbought, and, when it goes below the 20%, it is estimated to be oversold.

Now, let's trade the signals:

1. Determine where your support and resistance levels are as they are important to know.

2. Check how extreme the overbought or oversold move is.

3. Wait for the actual crossover of% K and% D in both your fast stochastic and your slow stochastic for confirmation and enter the trade.

4. Make sure to enter your stops using the resistance and support lines to determine them.

5. Take profits early before the next reversal event. You could use the next crossover as your “take profit” signal.

6. This is actually a lesson I learned years ago, do not get frustrated if you exit too early and made less profits than you could have. Keep in mind that you are never going to lose money by taking profits no matter how small the profit may be.

As you can see, this strategy is very simple, yet extremely effective.

Make sure to combine the stochastic oscillator with other indicators. The Relative Strength Index and the Bollinger bands work extremely well with stochastic.

When you have an easy swing trading strategy like the one we discussed implemented, trading becomes fun because, while you are not stressing out with the implementation of your strategy, you are still making great profits!