It seems like one of the most common questions asked is, “What is the best indicator to use?” This, of course, is an almost impossible question to answer. Because there are so many different indicators available, as well as so many different types of trading styles, that there is not going to be “the best indicator” for all situations. Indicators come in all shapes and sizes and some may work better with certain strategies than with others. The key is to find an indicator and adjust it so it works best within the system or strategy you are trading. Once you approach using indicators like this you can use almost any indicator to your benefit. What this tells us is that it is not so much which indicator we use, but how we use it.
In our article today, we are going to discuss one specific indicator. This is not to say that this indicator should be the only one we use or that it is the best indicator to use. In fact, we could have chosen any indicator and evaluated how to best use it within our trading. In this case, we are going to look at how we can better understand the stochastic indicator, as well as how it is commonly used. Just remember that it is how we use the indicator that will dictate whether or not it will be useful in our trading.
To begin, let’s take a quick look at what the stochastic indicator looks for. This indicator was created or developed back in the 1950s by George Lane. It was created to help identify the momentum of the price movement. It can be used to identify these momentum shits by looking for divergence, as well as looking for changes in price movements when the price is in an area of overbought or oversold.
The stochastic itself is made up of two primary lines. The %k line and the %d line and they are calculated as follows:
%k = (Current Close – Lowest Low) / (Highest High – Lowest Low) * 100
%d = 3-Day Average of %k
The lowest low and highest high is for the specific time period chosen. This means that if you are looking at a 14-period stochastic, you will be looking at the highest high and lowest low over the last 14 candles or bar. There are various versions of the stochastic indicator that have been created, including the fast, the slow, and the full stochastic.
The way that this indicator is set up is that it will generally oscillate between a high of 100 and a low of 0. As the price begins to increase in price, the stochastic lines will begin to move up, and, as the price begins to decrease in price, the stochastic lines will begin to move down. This fluctuation, or oscillation, in movements will signal possible times to enter or exit a trade.
The most commonly used way to trade the stochastic is to look to buy as the price moves above the 20, after being below it, and to short when the indicator moves below 80, after being above it. This oscillation in price can show us times when it is considered overbought and oversold. Take some time to practice trading with the stochastic indicator to see if it can help you better identify times to enter and exit your trades.