How to Trade Stochastic Oscillator Indicator. My Trading Strategy
Stochastic indicator alone provides very weak signals.
I will teach you how to analyse the behavior of Stochastic Oscillator and combine that with historical price action for predicting oversold and overbought markets.
Get step-by-step guide with real examples on Forex.
Recommendations for Using Stochastic
The best time frame for using Stochastic for confirming oversold & overbought state of the market is a daily.
I also recommend changing the settings of the indicator a bit.
The upper band should be 90, and the lower band should be 10.
It will make the indicator more precise.
How Stochastic Oscillator Works
The idea is that when the indicator reaches or drops below the lower band, the market is oversold.
When the indicator reaches or exceeds the upper band, the market is overbought.
Stochastic Weakness
The problem is that the market may remain oversold/oversold for an extended time period before the market reverses or pulls back.
As you may observe, Stochastic has been oversold for a long time on NZDUSD while the price keeps falling sharply.
Empower Stochastic with Price Action Analysis
Good news is that you can easily empower Stochastic, considering its behavior and historic price action.
Start your analysis from the identification of important historical supports and resistances on the instrument that you trade.
Make sure that the price tests one of these areas first.
Only then start checking the Stochastic.
On USDCAD pair, we see a test of a significant daily horizontal resistance.
Its test aligns with an overbought Stochastic.
Stochastic Oscillator Behavior
The final confirmation is based on the Stochastic behavior.
It should start coiling within a range or triangle.
Such a behavior signifies an ongoing accumulation/distribution of trading volumes.
An overbought state of the market is confirmed with a bearish breakout of the support of a triangle/range.
We can expect a pullback then.
For entries, I suggest using 4H time frame.
Your take profit should be based on the closest 4H support.
Stop loss should lie above the high.
Find the entry to have at least 1.1 reward/risk ratio as I did on USDCAD.
The target was quickly reached.
Oversold Stochastic Trading Example
Now, check the price action on EURUSD.
Stochastic Oscillator has remained oversold for a long time.
The indicator started to coil and formed a triangle, approaching an important historical support.
The resistance line of the triangle was broken, providing final confirmation.
A buy trade is take on a 4H time frame with a stop loss below the low and TP - the closest 4H resistance.
Summary
This Stochastic strategy is very powerful in predicting pullbacks.
Just be patient and wait for a strong confirmation before you open the trade.
Use this method for trading Forex, Gold or any other market.
