Stochastic Oscillators: Some Simple Tricks For Anyone To Profit From Stochastic Oscillators

Posted by on Jan 31st, 2011 | no comments home title

Stochastic oscillators as an expression contains the work “stochastic”, which in a strictly mathematical sense signifies a process with a randomly determined sequence of observations. Each one of these observations is considered a sample from a probability distribution.

In technical analysis, the term has evolved to mean an indicator that compared the current closing price with the highest high and the lowest low over a number of days.

Stochastic oscillators were developed in the late 1950s by George C. Lane. Nowadays it’s mostly used to identify overbought and oversold conditions, in a similar way to Relative Strength Indicators.

Similarly to RSI, Stochastic oscillators always range between 0 and 100%. 9% means that the currency’s price is the lowest it has traded at for the last x period. 100% means that the exchange rate is at the highest it has traded over the x time periods.

So here is how you can profit from stochastic oscillators:

Go long when the stochastic oscillator falls below a certain level (say 20) and the rises above it. Go short when the index rises above a given level (say 80) and then falls below it.

Buy then the %K line rises above the %D line and sell when the %K line falls below the %D line

To take your trading strategy one level further, look for divergences – For example, if the exchange rate was making a series of new highs and the stochastic oscillator is failing to go above its previous highs.

You can also profit from stochastic oscillators by using them as a confirmation signals:

A buy signal arises when the %K or %D falls below a given threshold (say 30) and then rises above it. A sell signal arises when the line goes above a given threshold (say 70) and then goes below it

Go long when the %K line rises above the %D line. Go short when the %K line falls below the %D line.

Another way of looking at this is that the “long/short” signals are generated when the %K line crosses the %D line after the %D line has changed direction. At the bottom a go long signal is created and at the top a go short signal is created.

If the forex rate is making new highs and the stochastic indicator fails to make new highs we have a divergence, and that may indicate a reversal in the trend.