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Trading with the

Stochastic Indicator

Personally I like to use the Stochastic Indicator as confirmation for any trade I am about to enter. Developed in the 1970’s by George Lane, he observed that in an uptrend, closing prices tend to be closer to the upper end of the candles and in a down trend, closer to the lower end of the candle. The stochastic was developed to discern the relationship between the closing prices and high and low of a candle. Normally used as an overbought/oversold signal the indicator consists of 2 lines: The %K and %D which fluctuate up and down on a vertical range between 0 and 100. Typically above 80 signals an overbought situation and below 20 signals an oversold condition in the market.

Buy and Sell Signals

When the faster %K line crosses above the slower %D line and both lines are below 20 then a buy signal is indicated. Likewise when the %K line crosses below the %D line and both lines are above 80 a sell signal is generated.

How to use the Stochastic in your daily trading.

As it is a lagging indicator and only gives buy or sell signals after the market has already turned I prefer to us it in conjunction with fib levels or Pivot points. So If for instance the Fib hits a .618 or a .764 level and the stochastic is in an overbought or oversold situation then it serves to confirm the trade provided, it is in line with the market trend that I have established previously. The same applies if the market hits a Pivot Point, support, or resistance level  and the Stochastic is overbought or oversold then I will trade it in the direction of the market trend only. The stochastic can be weakened, showing the hand of the weaker players by changing the value to 8,3,3 thus also creating more trading opportunities. We don’t use the stochastic as a stand alone signal but only in conjunction with other trading methods. If the trend is long I will ignore shorts and if the trend is short I will ignore the longs. Play around with the settings and try to add this indicator to your arsenal of trading tools. Try to find the method that best suits your trading style!