A stochastic oscillator is a momentum indicator comparing the closing price of a security to its price range over a specific period of time. It is one of the earliest technical oscillators in securities trading used to predict future market direction.
‘Stochastic’ is the Greek word for ‘random’, and in the context of trading refers to using past actions to forecast a future state. The word ‘Oscillator’ refers to repetitive variations up or down the equilibrium position.
Below are 3 simple steps to make the most out of a stochastic oscillator you can use when trading the slow stochastic.
The strategies increase in complexity as we progress through each of the examples.
Therefore, it would be wise to approach each strategy with an open mind as they will challenge the conventional thinking of how to use the slow stochastic indicator when trading Forex.
Step 1 – Identify a stochastic oscillator with smooth slopes
Stochastics that have smooth slopes, which move from overbought to over sell, imply that the move down was sharp and without much reaction. This, in turn, strengthens the odds of a counter move up.
While this is potentially the simplest of slow stochastic strategies, it still has its flaws.
For starters, sharp moves up or down can start consolidation patterns prior to continuing the trend. If you were to simply place buy and sell signals because of the smooth slow stochastic slope, you are headed down a rough road.
Step 2 – The Pop Method
Another trading trick is the POP Method. The basis of this system is to enter long trades when the index goes above 70 and sell trades when it goes below 30.
Trades are closed when the stochastic crosses the overbought (for buy trades) or the oversold (for sell trades). This method performed well at the 70’s and 80’s and works even today on Forex pairs that trend strongly, such as the GBP/JPY.
Step 3 – Combine the slow stochastics with trendlines
As we just mentioned earlier in this article, the slow stochastics can provide a number of false signals. The best way I have determined to overcome this flaw is to combine the slow stochastics with trendlines in order to identify proper entry and exit points.
So, if you are looking to benefit from stochastic oscillators in your own Forex trading, I recommend that you try out the 3 steps above and see how your trading could improve.