Overbought and Oversold are the two most powerful concepts in trading the Forex. Understanding that a market that is over bought will fall and that an oversold market has no choice but to rise takes a lot of confusion away from trading. So having simple to use indicators that tell when a market is trading in these extremes becomes vitally important.
Enter The Stochastic
Invented by George Lane the stochastic is based on the relationships of where a market closes in relationship to their highs and lows. George noticed that when a falling market is about to turn its closing prices tend to be near their daily lows. And of course the opposite would be true in a booming market that is about to turn south.
Based on this Mr. Lane built a simple indicator called a stochastic.
The Insides
Obviously the math behind the stochastic indicator is lengthy but lucky for you and I most charting services provide the indicator as a free service with their charts. Peeking inside the stochastic you will noticed that it has two lines that are smoothly rising and dropping and crossing each other in their paths. The two lines are represented by the titles %K and %D. The lines represent this relationship between the closing price and the daily high and low. The reason there are two lines is due to sensitivity – the %K is set up to be more sensitive to the market fluctuations than the %D and it is also a moving average of %K which is why it lags a bit behind.
These lines are plotted on a scale of 1% to 100% and it is in this scale that the trade signals are made.
Trade Signals
A good Forex trading signal is when the stochastic enters the upper 80% region, or the lower 20% region. This is the range where the markets are becoming over bought or over sold respectively. And the official “trigger pull” moment comes when the %K and %D cross each other inside these regions.
The beauty of this signal is that it is simple and it conforms to the principle of overbought and oversold. It is not predictive but rather helps to clear up the crazy price movements of the Forex markets.
Forex Indicators – The Power of Stochastic Indicators in Highly Profitable Forex Trading
09-10-2010 by adminNo Balance Transfer Fee Card
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