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Many traders in their forex trading strategy simply pick levels and buy or sell into them and hope they hold. This simply sees them lose, as they are hoping levels will hold and NOT acting on confirmation of price momentum to put the odds in their favor.
Here we are going to look at the ultimate momentum indicator that will help you time your trading signals with laser accuracy.
The momentum indicator we are referring to is the stochastic and it simply should be considered by anyone serious about making money in forex trading.
The logic
Of the stochastic is based on the assumption, that when a market is rising, it will tend to close near the highs of the session - and when a market falls, it tends to close near the lows.
Lets look at the calculation – although you don’t need to understand just as you don’t need to understand an internal combustion engine to drive a car – you can look at it visually which we will return to in a minute first:
The Calculation
The stochastic oscillator is plotted as two lines called %K, a fast line and %D, a slow line.
• %K line is more sensitive than %D
• %D line is a moving average of %K
• %D line gives the trading signals
It’s actually similar to the way a moving average is plotted.
Therefore consider %K as a fast moving average, and %D as a slow moving average.
The lines are plotted on a scale of 1 to 100 scale.
"Trigger" lines are normally drawn on stochastic charts at the 80% and 20% level – this indicates when markets are overbought, or oversold and a trading signal maybe generated.
Using Stochastics
The best way to get a feel for stochastic and how they can help your forex trading strategy is to look at them – you can see them free on many services and a good one is futuresource.com
The 80% value is normally used as an overbought signal, while the 20% is used as an oversold signal.
The signals are even more reliable if a forex trader waits until the %K, and %D lines turn upward, below 5% before buying - and in conversely, above 95% before selling.
The most reliable way to trade stochastic is to use the above as a warning sign and wait for the stochastic lines to cross with bullish or bearish divergence.
For example, buy when the %K line rises above the %D line, and sell when the %K line falls below the %D line.
Beware of short-term crossovers these can generate a false signal and cause losses.
The best crossover is generated when the %K line intersects, “after” the peak of the %D line.
Don’t worry if it sounds confusing it becomes much easier when you look at the set up on a chart service such as the one we referred to earlier and you will soon be getting the hang of them.
Why they are so valuable
Because they allow you to shift the odds in your favor instead of relying on hope when you trade into support or resistance you will shift the odds in your favor by knowing the strength of price momentum.
Stochastics are the ultimate timing tool for traders and allow you to enter your trading signals with the odds on your side. In any forex trading strategy you need to trade the odds and the stochastic is a powerful weapon that you can use for currency trading success.
Discover the stochastic indicator and you may be glad you did.
