Stochastic Oscillator and Divergence
Stochastic indicator at this stage is considered to be the most popular due to the fact that it works in corrections, defining with precision the movement’s direction (change) of the price at which it tracks closing prices within the series (which was the last) of the bottoms and the peaks.
Traders, both beginners and professionals with the experience, have long appreciated Stochastic oscillator due to the fact that it forms obtained values close to the maximum in a downtrend, when minimum values and rising trend are stored at the market.
Let’s touch on a little history of this indicator’s creation. Stochastic Oscillator was developed by Investment Educators president – George C. Lane in the middle of the last century (in 1950.). With the passage of time due to changes in market trends the indicator has been subjected to some changes. Its simplicity and accessibility make this an oscillator quite popular among traders.
Due to the fact that, by definition, stochastic indicator refers to oscillators, so it is designed to process information about the level of oversold and overbought and market volume.
Stochastic indicator specifies also times when the market turns, especially when it comes to large timeframes. The method of current range of closing prices comparing with the prices for specific periods of time put in the basis of this Forex market oscillator.
As for the graphics, the figures presented with two lines, namely:
- K% period – is the main line of the indicator, which is shown by the solid line.
- D% period – is considered as secondary line of the oscillator, and it is reflected in the graph by dotted lines.
- In order to interpret stochastic indicator chart the trader should use two additional levels – 20 (oversold level) and 80 (overbought level).
Signal 1. Both lines of stochastic oscillator, both main %K and secondary %D, firstly drops below level 20, and then are starting to rise, thereby cutting it again, only in the opposite direction. This situation suggests that the market is oversold and it is time to buy. The trader should sell when main and secondary lines cross 80 level, followed by a fall.
Signal 2. When secondary line %D crosses main %K line from top to bottom, in this case, the trader should look for sell signals. If secondary line has crossed the main from the bottom to top – it is buy postition.
Signal 3. Forex divergence, when the price chart forms new lows and highs, while at the same time, a breakthrough of new low or high is not confirmed by stochastic indicator on the chart. This is a sign of the fact that the market is oversold or overbought and sharp rise or fall is expected soon.
As the graph shows, the divergence is detected by stochastic indicator confirmed and the trend changed its direction to the other side soon.
By the way, the main signal, which Stochastic Oscillator shows is just a signal that current trend is beginning to wane.
The main advantage of the stochastic oscillator is its ability to work in the trade corridors.
There are some disadvantages of oscillator working. These include a large enough number of false signals oversold or overbought wives under trend development.
Nevertheless, the use of stochastic indicator bears undeniable advantages that help to react to the situation in time.