Today, we’ll delve into the topic of trading using a stochastic indicator.
The stochastic indicator gauges market momentum and trend strength, providing valuable insights into price momentum just moments before a reversal.
This timely information offers an excellent opportunity for entering or exiting the market, ultimately leading to potential profits. In this tutorial, I’ll guide you through efficient and professional trading techniques using this indicator, supplemented with practical examples to illustrate the trading strategy.
But first, let’s establish what a stochastic indicator is.
Momentum is like throwing a rock into the air: initially, the speeds are very high, but as the rock ascends, its velocity gradually decreases.
The same as momentum, the price momentum at the beginning is very high and wanted to go higher and higher and as the price go up and the time pass by you see the momentum of the price reduces and it reduces until it comes to to stop. and then it reverses, and the price reverses just a moment after the price reverses and going down.
Crucially, momentum always shifts direction before the price does. The stochastic indicator is a momentum indicator. It’s expressed as a percentage, ranging from 0 to 100, and is divided into two zones: the oversold zone, falling between 0 and 20 percent, and the overbought zone, spanning from 80 to 100.
Some traders follow this technique to enter and exit the trend.
In overbought zone if the red line crosses the blue line and cutting the 80 line while going downward, it generates a SELL signal.
In oversold zone if the red color crosses the blue curve and cutting the 20 line while going upward it generates a BUY signal. please do not mistake this as trading strategy, because it is not rather it is an entry trigger, to get you into the trade.
The overbought area represents a zone where the uptrend’s momentum is strong and shows potential for further upward movement. Regrettably, some traders make the mistake of going short as soon as the price enters the overbought zone. Prices can remain in the overbought zone for an extended period, steadily rising, leading to significant losses.
The oversold area is a zone where the downtrend’s momentum is substantial, indicating a willingness to move even lower. Regrettably, some traders make the mistake of going long as soon as the price enters the oversold area. Prices can linger in the oversold region for extended periods, potentially weeks or even months, continuing their descent and resulting in financial losses.
The stochastic indicator serves as a valuable tool, offering insights into where momentum is shifting before the price itself reverses. This predictive ability makes it a valuable asset for anticipating future market movements.
- Download “TraderVersity-MovingAverageStochasticSystem” (Zip/RAR File).
- Copy mq4 and ex4 files to your Metatrader Directory …/experts/indicators/
- Copy the “TraderVersity-MovingAverageStochasticSystem.tpl” file (template) to your Metatrader Directory …/templates /
- Start or restart your Metatrader Client.
- Select Chart and Timeframe where you want to test your forex system.
- Right-click on your trading chart and hover on “Template”.
- Move right to select “TraderVersity-MovingAverageStochasticSystem” trading system and strategy
- You will see “TraderVersity-MovingAverageStochasticSystem” is available on your Chart
Let’s start by examining the price trend on the D1 time frame. I’ve set up a 14-day stochastic indicator and a 100-day simple moving average. The chart clearly defines overbought and oversold areas, with zones marked at 20 and 80.
To initiate a trade, your first step is to determine the trend’s direction on a longer time frame, such as the D1 time frame. It’s crucial to align your trading strategy with the prevailing trend, not against it.
As you can observe on the D1 time frame, the trend is pointing downward. In this scenario, it’s advisable to consider a Short trade.
To enter a SELL trade, shift to a lower time frame, in this case, the H1 time frame. Here, apply your price action analysis, including patterns, formations, and candlestick patterns.
Consider taking a short position immediately after a well-timed bearish reversal pattern, right as the stochastic oscillator moves out of the overbought area.
These are the optimal entry points for executing SELL orders, representing a professional approach to trading.
In this chart, I’m going to demonstrate how to trade with the stochastic indicator like a professional. This is the price trend on the D1 time frame. Just like the previous example, I’ve installed a stochastic indicator with a 14-day period and a simple moving average with a 100-day period. remember you can use 100, you can use 150, you can use 200. it’s it’s your preference.
The chart highlights the overbought and oversold areas, as well as the two zones in the stochastic indicator: the twenty percent and eighty percent zones.
To initiate a trade, your first step is to determine the trend’s direction on a longer time frame, such as the D1 time frame. The goal is to align your trading strategy with the prevailing trend, rather than going against it. In this case, the trend is ascending on the D1 time frame, indicating a potential BUY trade.
in order to enter the market, you go one time frame lower. H1. so you go to H1 time frame, and use your price action. such as pattern and formation and also candlestick pattern, and you see a sign of uptrend.
Consider taking a long position immediately after a well-timed bullish reversal pattern, right as the stochastic oscillator moves out of the oversold area. This is the professional way to enter the market.
In summary of this strategy, here are the key steps to enhance your trading approach:
- Employ the 100-day Simple Moving Average (SMA) to determine the trend direction on a longer time frame, such as D1.
- Leverage the Stochastic indicator to pinpoint overbought and oversold levels within the trend on the D1 time frame.
- Utilize candlestick and chart patterns or the Stochastic indicator as entry triggers on a shorter time frame, like H1.