How to ‘predict' the forex market's next move using the stochastic oscillator

by , 11 August 2015

Knowing when a currency pair price hits an extreme is very useful. It usually indicates a change is ahead.

You can use different types of oscillators to show you when this happens. One of these oscillators is the stochastic oscillator.

So how does it work?

Let's take a closer look…

How the stochastic oscillator works

A stochastic oscillator works on the premise that:

  • When the price of a currency pair is peaking, the closing prices tend to approach their daily highs; and
  • When the price of a currency pair is bottoming, the closing prices tend to approach their daily lows.

The stochastic oscillator gives you lines plotted on a scale of 1 to 100. A currency pair is overbought when it hits 80 and over, and oversold when it hits 20 and under.

You can also use the stochastic oscillator for indications of when a reversal is on the cards:

  • Bullish reversal: When the line hits 10 or below; and
  • Bearish reversal: When the line hits 90 or above.

Have a look at the stochastic oscillator below the price chart…

Chart showing a stochastic oscillator

Reading forex indicators from a stochastic oscillator

Making up the stochastic oscillator are two lines:

  • %K: This is the solid line on the chart above and is the plotted instrument.
  • %D: This is the dotted line on the chart above and is the moving average.

The way these two lines interact generates further forex indicators.

If the %K line crosses the %D line, this tells you the immediate trend is changing.

If the %K line cross the %D line from the bottom up, this is a bullish signal. And if the %K line crosses the %D from the top down, this is a bearish signal.

So there you have it. How to ‘predict’ the forex market’s next move using the stochastic oscillator.

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