Hello guys, today we're going to talk about the Stochastic Oscillator, the stochastic
is an indicator that measures momentum.
Price momentum is the rate of change of the price and usually momentum changes before
the price reverses, so stochastic is useful for measuring divergence.
Stochastic is also an oscillator, that means it shows the price relative to a previous
high-low range so it's useful for identifying oversold and overbought areas.
Stochastic oscillator plots 2 lines the first line is called the %K line and the second
line is called the %D line.
The formula for the %K line is (Close - Low)/(High-Low)*100.
The default value of the indicator is 14 periods but you should play with your settings depending
on your trading system and set it to whatever suits you best.
14 periods on the daily for example time frame will represent the value of the indicator
for 14 days.
Let's go to cTrader where I am going to show you how the stochastic oscillator looks like.
So I have plotted here a EURUSD 1-hour chart so let's press the f button which is for indicators,
let's go to oscillators and lets find the stochastic oscillator.
The default value of the indicator is 14 periods and we see here in the window that we can
configure the %K periods, the %K slowing, the %D periods and the type of the moving
average.
The %K periods is the main setting for the indicator and it configures the period for
stochastic.
The %K slowing, usually we leave this at 3, this is the default value.
When the indicator first came out there used to be a fast stochastic and a slow stochastic,
if you use the value 1 it's going to be the fast 3 is the normal value.
The %D periods is the periods of the %D line which is the moving average of K.
So let's plot this indicator, we see that the indicator is oscillating around level
50.
It's minimum value is 0 and it's maximum value is 100.
It's considered to be oversold at level 20 and below, and overbought at level 80 or above.
The green line that we see here is the %K line, and the red line is the %D line.
Let's see how you can use the indicator in range and trend markets, if you don't know
what a range or a trend market is, you can check out episode 7 that explains these concepts.
The first and most obvious signals that you get from stochastic oscillator is identifying
overbought and oversold areas, as I explained before it's considered to be overbought above
80 and oversold below 20.
You cannot be however trading all these signals randomly, you have to be trading the signals
in context.
That means that you have to establish if the price is doing any higher lows or higher highs,
because going short and long with overbought and oversold areas works better in a range.
So let's go back to cTrader, in this case in the EURUSD chart we see that the price
is currently not making any higher lows or higher highs, so it's not trending it's just
oscillating.
So using the oscillator, I am going to mark the level 20 and level 80 for you, for overbought
and oversold areas it's going to be a good strategy to use.
So you see, you can go short here, it's considered overbought, we're going to get money, we can
go long here, again we're going to make money, here we have another short signal, again we're
going to make money, long signal, we're going to make money.
You see all these signals are very successful, if the price is not trending.
The indicator doesn't provide a way to put your stop loss so you can be using a risk
to reward ratio, you can use any other stop loss methods when placing the orders.
It also makes sense to use Japanese candlesticks when using any type of reverse strategy, like
this strategy that we are using now, so for example you can wait when the price goes above
80 or below 20, you can wait for some reversal that you confirm with Japanese Candlesticks,
like the hammers that you see here or anything like that.
If you're not familiar with candlesticks, we can watch episode 9.
However if you establish that the market is trending, so if it's doing higher lows and
higher highs, for example in an up trend, then you are not supposed to be taking all
the signals of the indicator.
You should only be taking all the signals with the direction of the trend.
So let's go back to cTrader where I have found a trend here, we identify a trend by, it's
doing higher lows and higher highs so we have an up trend, we see here.
In this case we're going to be taking only the signals that go with the direction of
the trend, because the price is going up, we don't want to take the opposite signals,
because we are going to be trading against the trend and there is a very high probability
that we are going to lose money, even even if we win we will not be making a lot of pips.
So in this case we should be taking this signal, and this signal,or this signal, this signal
all those signals are going to be successful because they are with the direction of the
trend.
Another way of using the stochastic oscillator, that is not very famous but it's very successful
is by plotting 2 oscillators with different periods.
One of the oscillators is going to give you the general direction of the trend, and the
other oscillator is going to be the one you use to enter your signals.
Let's go back to cTrader where I am going to show you exactly what I mean.
We have here the first stochastic oscillator that we drew, the one with the default periods,
so what we're going to do is we're going to draw one more stochastic, this one is going
to have high periods.
I am going to put 150 for %K and 75 for %D, and then what I am going to do is I am going
to remove the %K line completely and we're going to mark the level 50, so here is the
level 50.
What we are doing now is, we have the big one, the one with 150 periods, giving us the
overall direction of the trend.
The market might not be trading all the time, but even the slightest slope, it's going to
show it to us.
The other indicator is used for entering the signals, so for example here, we see that
this indicator the big one, is above the 50 line that means that my direction is long,
so what I am doing is I am going to the small one, the fast one and I am getting only the
long signals like this one, this one, this one, and I am successful because I am trading
with the overall direction of the trend.
Then again when it goes short again I am doing the same thing, now it went below 50 line,
so I can be getting all the short signals and again I am going to be successful.
So this is a nice trading system especially for those of you who have difficulties identifying
the trend.
The last way of using stochastic oscillator is for spotting divergence which is the most
popular way, and it's actually the reason why the creator created the indicator, mostly
for spotting divergences, so let's go back to cTrader where I am going to show you, we're
going to use the small stochastic indicator here so lets remove the big one, the big indicator
let's press the x button to remove it.
A divergence occurs when the price is going towards a specific direction and has a specific
slope, for example here, the price has an up slope and the indicator has the opposite
slope.
Let's remove the %K line because we use the %D line for spotting divergences and as you
can see here the price is constantly doing higher highs, however the indicator is not
doing higher highs it's going lower, especially this spot here exactly the price is going
to the same level, however the indicator starts going low, so we have the opposite slope,
so it makes sense to go short.
We spot for divergences after a trend, because divergences are used to reverse.
So in this case we can enter short, and we're going to make money, again the same thing,
here then the price is doing a downwards slope, it's going down again the indicator shows
another divergence in this spot, see the price is going up, the indicator, the price is going
down and the indicator is going up so, we can also enter long here again we're going
to make some money.
In this video we talked about the stochastic oscillator and I showed you how to use it
in your trading and how it's calculated.
Usually we use the stochastic oscillator to get the overbought and oversold areas, to
spot divergences, and we plot it two times to find the overall direction of the trend.
In the next videos we're going to talk about indicators created by Larry Williams or maybe
we're going to do momentum oscillator.
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thanks for watching.