Forex Lesson 5: Stochastics

Stochastics are a pair of indicators that usually fall between the levels of 80 and 20 on a chart. The pattern that stochastic indicators follow can be used to predict the market trend. If the stochastic indicators break out either above the 80 level or below the 20 level and cross each other there is an indication that the market is either overbought above the 80 level, or over sold below the 20 level.

Stochastic indicators will mirror the pattern of a range bound market and remain within the boundaries of 80 and 20 with little deviation from their pattern. What is worth noting is if stochastic indicators either breaks through the 80 or 20 levels whilst the market is still range bound. If the stochastic indicators do break through these levels then it is an indication that the market may follow in the same direction with a price increase over 80 and decrease below 20. When the stochastic lines cross then return to the area between level 80 and 20 then it is a signal that the currency pair has been either overbought or oversold and the current trend is coming to an end.

Stochastic indicators are a good way of analysing markets when we believe that a trend is going to reach a new high or new low. In the last lesson we mentioned a pattern in a trending market similar to a rollercoaster where a double peak of resistance can be clearly seen. A trader assuming that the market will go long after breaking the second point of resistance can use a slow stochastic indicator to check the prediction. If the slow stochastic indicator concurs with the prediction and breaks through the 80 level without crossing or showing signs of returning below the 80 level, then the price increase is likely to follow. However if the slow stochastic indicators cross over above the 80 level then go in the opposite direction then it is likely that a reversal will ensue. The same is true with the double low pattern like the twin dips of a rollercoaster. If the candlesticks fall below this double low dip and the stochastic indicators also break through the 20 level without crossing or showing signs of returning then the price fall is likely. If however the stochastic indicators crossover then shows signs of returning to the area between 20 and 80 then the price fall is not confirmed and is likely to rise again.

Stochastic indicators can be used to confirm points of support and resistance in candlestick patterns. A perceived point of resistance in a candlestick chart can be checked with the stochastic indicators. A line of resistance can be drawn on the stochastic indicators. If the stochastic indicators’ line mirrors the candlestick’s resistance line and is horizontal then the resistance point is strong. If however the stochastic indicator’s line moves in a downward direction then the candlestick line of resistance is not sustainable and the price will decrease. If the stochastic line of resistance continues in an upward pattern then the candlestick line of resistance is unsustainable with the price likely to increase further. The same is true with lines of support. If the stochastic line of support mirrors the candlestick line of support and is horizontal then the candlestick support line is strong. If the stochastic indicator’s line of support is not horizontal and moves upward then the candlestick line of support is not sustainable and is likely to increase. If the stochastic line of support were to move downward this would also indicate the candlestick line of support is unsustainable with the market likely to drop further.

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