Learn Stochastic

One of technical analysis tools is using Stochastic chart, this chart is freely available in your Meta Trader program.

The Stochastic indicator was developed by George Lane in the early 1960's, its idea based on the assumption that when the price increases it tends to be closed near the high of the recent price range. Conversely, when the price decreases it tends to be closed near the low of the recent price range.

 

How does Stochastic indicator work?

The Stochastic is a momentum oscillator that oscillates between 0 and 100 and consists of two lines :

 

 

%K: This is the main line and called the fast line, it displayed as solid line

%D: This line called the slow line, it displayed as dotted red line

 

Calculation:

The Stochastic indicator in MetaTrader platform takes five parameters which used in its calculation :

%K Periods: The number of periods (bars) used in the Stochastic calculation.

%K Slowing Periods: The smoothing rate of the %K line, 1 for example means it’s a fast %K and 3 for example means slow %K.

%D Periods: The number of periods used for calculating the moving average of %K and which produces %D line.

Price field: The type of price used in calculating the moving average of %K which can be one of: High/Low or Close/Close.

MA method: The method (Exponential, Simple, Smoothed, or Weighted) of the moving average of the %K line.

Those were the parameters, and the formula of the calculation is as the followings:

%K = (CLOSE-LOW(%K))/(HIGH(%K)-LOW(%K))*100

Where:

CLOSE is today's close price.
LOW(%K) is the lowest low in %K periods.
HIGH(%K) is the highest high in %K periods.

Then the %D line is calculated as following:

%D = MA(%K, N)

Where:

MA is the moving average which you has chosen its method (Exponential, Simple, Smoothed, or Weighted).
N is the smoothing period of calculation.

How to trade using Stochastic indicator?

There are three method of using the Stochastic indicators:

1- Overbought / Oversold:

When one of the stochastic line crosses the 20% and 80% levels it means it was an Overbought or Oversold market moods.
We Buy when the stochastic falls below 20% level then rises above it.
We Sell when the stochastic rises above 80% level then falls below it.

2- Crossover:

We can treat the %K and %D lines of the stochastic indicator very much like two moving averages indicators one of them is fast and the other is slow and play the crossover game.
We Buy when %K crosses down up the %D.
We Sell when the %K crossed above down the %D.
Note: The crossover of the stochastic line often provides choppy signals that need to be filtered with another indictor(s).

3- Divergences:

Divergences between the stochastic lines and the price is a good signal for Buying or Selling the security. For example, if prices are making a series of new highs and the stochastic is trending lower, you may have a warning signal of weakness in the market.

 

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