There are a host of things to think about when using the stochastic oscillator in Forex trading. The first thing you need to understand is whether it’s appropriate for the trading environment that you are working in. This is when adding the moving average can help, making sure that you are using the right tool in your toolbox for the job at hand.
That being said, the stochastic oscillator is much less useful with a strong trend. It can be used, however, to spot divergence, but you should keep in mind that divergence is probably best used on a longer-term timeframe such as the four-hour chart or above.
Ultimately, one of the great things about the stochastic oscillator is the fact that it’s such an old indicator that you can be sure that plenty of other traders out there will be paying attention to the same signals. In a sense, this is part of what makes the stochastic oscillator work.
While the increase in algorithmic trading would have got traders thinking that some of these old indicators aren’t being used, the exact opposite is true. Because of this, some of the more commonly used indicators will more often than not be part of an algorithmic program to fire off trades. In other words, the stochastic oscillator will continue to be used heavily by the trading community.
The stochastic oscillator allows traders to see the overbought or oversold condition of a market
The stochastic oscillator is used for consolidation ranges
The stochastic oscillator spots divergence between momentum and price
The stochastic oscillator is commonly used, therefore has a certain appeal
Ultimately, if you are going to use the stochastic oscillator it is best to match it up with another indicator in order to determine trend. At the very least, you should be aware of any trendline analysis that will let you know whether or not you are in the right type of market conditions.
If you are, stochastic oscillator becomes a very useful tool. However, if you are in an extreme trend, it can be very expensive to follow. For this reason, it’s rare to see analysis with a stochastic oscillator not accompanied by at least one other indicator.
If you are going to use it, start out with a demo account and test how it behaves with your system. The stochastic oscillator is a great addition to your toolbox, but it’s not a system in and of itself so therefore it should not be thought of in those parameters.
It’s quite common for traders to use a stochastic oscillator when the time is right, but switch to something like the Relative Strength Index as an oscillator when we see the market jump out of consolidation. Quite often, traders will simply go back and forth between two oscillators, depending on what the moving averages or a trendline is telling them.
While that’s true, there are other settings that traders can use but you should be aware of the fact that if you extend the settings further out, it gets rid of the sensitive and reactive nature of the stochastic oscillator, which makes it such a great range bound indicator.
Knowing your situation, and the limitations of this tool, will greatly increase your success.