The forex market commonly referred to as FX market offers ample opportunity to earn profits. There are many technical indicators in the forex market that can be used to predict the currency movement. One such technical indicator is the stochastic indicator. This is widely used in the forex market and is one that is opted for by majority of the forex traders.

The Stochastic indicator was developed by George Lane towards late 1950s. This indicator is made up of 2 lines. They are –

1. %K – is a solid line and is the main line. It is more sensitive of the 2 lines.

2. %D – displayed as a dotted line, this line is a moving average of %K .

The %K compares previous closing price and the current closing price. %D serves as a signal line. The lines of the stochastic indicator are plotted in the range of 1 to 100.

Using stochastic indicator in trading currencies appears to be very simple but in reality there are very few FX traders that use it correctly. It is a well known fact that the market shows fluctuations at any given period. This enables you to measure the momentum or the velocity of the existing trend in the FX market.

Stochastic works on the principal that when prices are escalating, the closing prices will be higher than what it was during periods when the market was flat and vice versa. Stochastic indicator helps you to predict the reversing trend in the forex market.

How will you interpret the stochastic indicator in FX trading?

The stochastic indicator is mainly used as an Overbought or Oversold Indicator. It will help you to find out at what point of time the market is overbought or the prices are higher than the real value. Conversely, it will also indicate when the market is oversold or when the prices are much lower than the real value.

When %K and %D are high

When %K as well as %D is high, it implies that the market is overbought. So, this is the best time to sell before the prices return to the corrected values again.

When %K and %D are low

On the other hand, when the 2 lines are low, it implies that the market is oversold and this is the best time to buy before the prices rise again.

Majority of the forex traders use settings of 70, 75 and 80 as the higher limit and 20, 25 or 30 on the lower side. A trade is usually triggered when prices rise or fall below these lines.

There are 2 ways in which the forex traders interpret when to start trading. One is by making use of the %K and %D lines and the other is by keeping a close watch on the higher and the lower limits.

If the prices fluctuate between 20 and 80, it indicates that trading should be initiated without further delay. Fluctuations that take place between 70 and 30 are considered normal and it indicates that you still have time to wait and watch for the market to change further.

In case you are focusing more on the relative position of %K and %D lines for starting a trade, you can watch out for these changes. In case %D is crossed by %K while ascending upward and crosses again while descending, it signals that this is the right time to buy.

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