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During the current hour the % K (%K represents the current status as compared to the lowest and highest levels) started going higher and crossed %D (%D represents the recent past of %K) and became current 20%. What does it tell us is that though we are still very slow but recently the speed has started increasing… the road conditions may be improving and may further improve to have faster speed. It may be the “Buying Time….” The Forex trading signals from Stochastic indicators come in 3 forms:
2. Over bought / Over sold situation 3. Divergence Fast Stochastic, Slow Stochastic and Full Stochastic – What is the Difference:Fast Stochastic and Slow Stochastic:Slow Stochastic was developed to avoid some false trading signals which the Fast Stochastic may give. As a recap:
- The %D line is SMA (Simple Moving Average) of the %K for previous 3 periods.
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As mentioned above, the “Fast Stochastic” indicator may give frequent false Forex trading signals as the price movement data is not smoothened. It’s like a person who is very anxious would jump at each movement to cry and shout “Wolf….” without thinking twice. The Slow Stochastic” indicator tends to be slow in giving signals i.e. less crossovers or less signals. In other words Slow Stochastic is not so fast in becoming anxious to cry and shout “Wolf” :)
The points marked by “F” in the above Forex chart indicate that though there was a crossover of %K line and %D lines, the signal were False” or “almost False” i.e. though a particular trading signal was not truly false but could not result in much profit practically.
(%K line going above %D line means uptrend or “buy” signal and %K line going below %D line means downtrend or “sell” signal for the concerned currency pair).
What exactly is the difference in Fast and Slow Stochastic from calculation point of view:
As mentioned above that “Slow Stochastic” was designed to take out some false signals. What we are trying to do is that instead of thinking just about very current price data we try to think a bit more about the recent movements. This gives more weight to the recent past data. In simple words it is like not getting very excited about today’s price movements but looking a bit deeper into the recent past data in order to take the trading decision.To find %K (slow) in the Slow Stochastic Oscillator, a 3-period SMA (simple moving average) is applied to %K (fast). This 3-day SMA slows (or smoothes) the data to form a slower version of %K (fast). In Fast Stochastic the %D is 3-period SMA of %K. In Slow Stochastic the %K is 3-period SMA of %K of Fast Stochastic. That means %K of Slow Stochastic = %D of Fast Stochastic. A close examination of figure 3 above would reveal that %D (Fast), in the Fast Stochastic Oscillator, is identical to %K (Slow) in the Slow Stochastic Oscillator.
To form the trigger line, or %D (slow) in the Slow Stochastic Oscillator, a 3-day SMA was applied to %K (Slow).
The Full Stochastic Oscillator:
The “Full Stochastic” combines the features of Slow and Fast Stochastic and gives us the flexibility to change parameters. Slow Stochastic is a slower version of the Fast Stochastic but Full Stochastic gives us an option as to how much slow we want to make it. It gives us an option to make it slower or faster. In Forex trading the price movements can be very volatile. In technical analysis taking into consideration analyzing the price movements in different time frame forex charts is quite important.
When we try to apply “Full Stochastic” to our forex trading chart, it would offer a default setting like “Full Stochastic (14,3,3)”. While when we apply Fast or Slow Stochastic the default setting offered would be “Fast Stochastic (14,,3)” or “Slow Stochastic (14,,3)”
The Full Stochastic Oscillator takes three parameters. Just as in the Fast and Slow versions, the first parameter is the number of periods used to create the initial %K line (for example if analyzing previous 14 periods and hence “14”). The last parameter is the number of periods used to create the %D (for example if %D is 3-period moving average of %K then this parameter = 3).
What the middle parameter is doing in “Full Stochastic”?:
Well, in Slow Stochastic for %K line we take 3-period moving average of the %K line of the Fast Stochastic.
(For ready reference: “To find %K (slow) in the Slow Stochastic Oscillator, a 3-period SMA (simple moving average) is applied to %K (fast). This 3-day SMA slows (or smoothes) the data to form a slower version of %K (fast).” In slow Stochastic we can not change this default 3-period SMA which is used to create the %K line of Slow Stochastic. The Full Stochastic gives us this flexibility. If we use 2 as the middle parameter i.e. Full Stochastic (14, 2, 3) then it will be 2-period SMA of %K of fast Stochastic which will be used to get %K of full Stochastic.
Summary Table for explanations about various kinds of Stochastic in technical analysis in Forex trading:
| Indicator | %K | %D |
| Fast Stochastic (14,3) Means analyzing past 14 periods for %K and for %D taking simple moving average of %K for prevoious 3 periods. |
Current price comapred to the highest price and lowest price of the selected period | 3 period moving average of %K |
| Slow Stochastic (14,3) | 3 period moving average of %K of Fast Stochastic = % K of Slow Stochastic. (this 3-period SMA is default and we can not change this value to lets say 2-period average) |
3 period moving average of %K of Slow Stochastic |
| Full Stochastic (14,X,3) | X period moving average of %K of Fast Stochastic = % K of Full Stochastic (so more flexible then Slow Stochastic) There is a middle parameter "X". If X= 3. then this Full Stochastic is same as the above mentioned Slow Stochastic. But if we change it to (14,2,3) then it is 2-period moving average of %K of Fast Stochastic = % K of Full Stochastic |
3 period moving average of %K of Full Stochastic |
How to use Stochastic Indicator in Forex trading:
The trading signals from Stochastic indicators come in 3 forms:
- 1. Over bought / Over sold situation
2. Crossover (the Stochastic line crossing the Trigger line)
3. Divergence
1. Over bought / Over sold situation for the currency pair
Readings below 20 are considered oversold (indicating that it may be the time to buy as people may start buying now and hence prices may go up) and readings above 80 are considered overbought (indicating that it may be the time to short sell as prices may go down).However, level above 80 does not necessarily indicate that people will not buy further and a reading below 20 can not conclude that people will not sell further. The price can continue to rise after the Stochastic Oscillator has reached 80 or crossed over 80 and continue to fall after the Stochastic Oscillator has reached 20 or gone below 20.
a) When Stochastic indicator is over 80, it indicates that it may go down but it can remain in 80 to 100 range for long time if negative sentiments do not come into the picture. In this case the uptrend can continue for a long time.
b) When Stochastic indicator is below 20, it indicates that it may go up but it can remain in 0 to 20 range for long time if positive sentiments do not come into the picture. In this case the downtrend can continue for a long time.
Summary: The 80 & 20 only indicate that the reversal would come but can not indicate the time when it will happen. The bullish sentiment (uptrend) can continue time even after the Stochastic is over 80 and similarly the downtrend can continue after the Stochastic goes below 20. Hence taking action only on the basis that Stochastic has crossed above 80 and hence prices would come down or Stochastic has crossed below 20 and hence prices would start going up may take us for a ride on the wrong side of the road. Avoid this reading in isolation as a signal.
Crossover (the %K line crossing the %D or trigger line):
Buy and sell forex trading signals can are also generated when %K crosses above or below %D.When %K line crosses the %D line (trigger line) from below to above, it signals that the price of the currency pair is moving up and may move up further. It gives us a “Buy” signal. Please note that the “Buy” signal by crossover is more authentic when the Stochastic is near or below 20 (over sold area). Avoid using this “Buy” signal when Stochastic is near 80 or above 80 (over bought area).
When %K line crosses the %D line (trigger line) from above to downwards, it signals that the prices are moving down and may move down further. It gives us a “Sell” signal for that currency pair. Please note that that the “Sell” signal by crossover is more authentic when the Stochastic is near or above 80 (over bought area). Avoid using this “Sell” signal when Stochastic is near 20 or below 20 (over bought area).
However, crossover signals of Stochastic in Forex trading are quite frequent and can result in a lot of false signals. The better results would be when the crossover takes place when the Stochastic oscillator moves from overbought territory back below 80 and from oversold territory back above 20.
Technical Analysis - Stochastic Oscillator (Forex Abode.com) – SO- Fig 4:
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In the Forex trading chart in figure 4 above:
Point A: The %K is above 80 i.e. in the over bought region. Over bought region just tells us that the currency is overbought and people may start selling and hence the prices may start falling. As mentioned earlier that %K reaching overbought region should not be taken as signal because in a strong uptrend the buying can continue and currency can remain in the over bought region for long time.
At point “A” %K was in overbought region but then crossed %D line from above to below. The price at point “A” was approx 1.5800 (1 EUR = 1.5800 USD). The prices went up but then subsequently went down to close to 1.5600. A profit of close to 200 pips if we short sold at the crossover at point “A”. It is always advisable to put a limit buy or sell order at few pips below or above respectively when the cross over takes place. It is to take care of the frequent correction in the opposite direction of the price movement. It adds pips to the profit than if we tend to buy or sell at the crossover point.
Point X (corresponding currency pair price approx 1.5700):
Stochastic was near 40 i.e. closer to oversold region (oversold region is below 20). At point X the %K line crossed %D line from below and moved up. This signals that the price may go up and that’s what exactly happened. The price moved up approximately 100 pips i.e. from close to 1.5800 to near 1.5900.
Point B: %K line crossed %D line from above to downwards. A signal that the currency pair price may fall. Price did fall but marginally and not substantially.
Next crossover at unnamed point after point B: The %K line crossed %D upwards. This signals that price for the currency pair may go up but this proved to be a false signal. A very important point to be noted here is that the Stochastic was around 60 and hence was neither in the oversold nor in the overbought region. The best crossover signals are as follows:
1) Buy: %K line crossing over % D line upwards when the Stochastic is below 20 (oversold region)
2) Sell: %K line crossing % D line downwards when the Stochastic is over 80 (overbought region)
If the crossover takes place when Stochastic is in the middle i.e. neither in oversold nor over bough region, please avoid taking an action immediately at the crossover. Wait a little to see if the price movement is really taking place in the direction indicated by the signal.
Point C: %K crossed %D from up to downwards. Even though the Stochastic was not in overbought region the price fell down heavily.
The very important point to be noted here is divergence shown by point A, B and C. Divergencs may prove to be the best trading signals and will be explained under the next heading.
2. Divergence
For the most reliable trading signal, wait for a divergence to develop from overbought or oversold levels. Once the oscillator reaches overbought levels, wait for a negative divergence to develop and then a cross below 80. Its better not to sell at the first dip below 80 but wait to see if it bounces back over 80 again. Most of the time it would bounce back over 80 after the first dip. The second dip results in the sell signal. For a buy signal, wait for a positive divergence to develop after the indicator moves below 20. It is better to disregard the first break above 20. After the positive divergence forms, the second break above 20 confirms the divergence and a buy trading signal is given.
Technical Analysis - Stochastic Oscillator (Forex Abode.com) – SO- Fig 5:
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Technical Analysis - Stochastic Oscillator (Forex Abode.com) – SO- Fig 6:
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In the above shown Fig 7 Point A was a peak in the over bought region. The Stochastic went down after point A and then climbed again before going down from Point B. The peak at point B was lower than point A. next peak at point C was lower than peak at Point B. And see what happened. When the %K line crossed %D line downwards near point C, the price fell real heavily.
Take a note of such divergences when the subsequent high or low points (peaks and valleys) are going lower than the previous peaks. It may give a good signal for an emerging down trend. Similarly if the subsequent high and low points (peaks and valleys) are going higher than the previous ones, it may give a good signal for an emerging uptrend.
Technical Analysis - Stochastic Oscillator (Forex Abode.com) – SO- Fig 7:
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In the figure 8 as shown above note that from the cossove at point P, the price moved higher as the signal suggested. Point Q was practically a false signal because the crossover took place neither in over bought nor in oversold region. Crossover at point R signaled short selling as it indicated that price may fall and prices fell marginally. Crossover at point S proved to be a very good signal. The price went up heavily. Note that the lowest point at S was higher than the previous lowest point at P. This was a case of divergence. Hence at point P we got two signals, one from crossover and another by divergence.
Please study the figure 9 below and practice analyzing it based on all the explanations above to see how the signals from the Stochastic worked.
Technical Analysis - Stochastic Oscillator (Forex Abode.com) – SO- Fig 8:
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We explained Stochastic Oscillator in the context of Forex Trading but the same stands good for stock trading or any commodity trading.
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Wish you successful Forex trading :)
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