Stochastics Can Be A Highly Profitable Indicator If Used Properly

Stochastics is one of the most popular indicators in forex trading. You can find it on almost all platforms and charting services. But most traders use them incorrectly. Stochastics is an oscillator that has two components %K and %D. This is the formula to calculate K=100(C-L)(H-L) where C is the Close, H High and L the Low of the period. Typically this period is 14 days. However, 9 days period is also popular. %K is the 3 day MA of K and %D is the 3 day MA of %K.

Fortunately, you don't have to go into all this maths unless you want to fiddle with it and see if you can make it work better. One common question is how many days to use in Stochastics. Stick with 14 days as it is the default. Longer period means lesser signals and lower whipsaw while shorter periods means more signals and more whipsaw.

Now when stochastics is above the 80 line, market is overbought and when it is below the 20 line, market is oversold. But buying and selling on overbought and oversold will simply won't work.

Overbought and oversold condition only works in the sideways market but it completely fails in a trending market. So, one way to overcome this failure is to buy when the stochastics is above 80 and %K crosses down below %D. Similarly, sell when the stochastics moves below 20 and %K crosses above %D.

A better method is to trade the %K and %D crossovers. %K is the faster moving line whereas %D is the slower moving line.

Left handed Crossover takes place as %K crosses %D when it is climbing whereas the Right Handed Crossover occurs when %K crosses %D hump from the right.

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