Chapter 12, Part IV. Stochastic.

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 Part IV. Stochastic.
Commander in Pips: Today we will talk about another widely used indicator – Stochastic. This is an indicator that unfortunately is very often used by traders in a wrong way. Some traders use them for trend identification, others – for estimating of overbought and oversold conditions on the market. Here we will discuss why Stochastic could not always be applied for those purposes. But before that, as usual, we start from simple description.

Pipruit: This will be interesting.​

DESCRIPTION OF STOCHASTIC

Commander in Pips: Stochastic consists of two lines and it’s similar to MACD in this sense. One of the lines is a fast one, second is a slow. But in distinction from MACD, Stochastic is a normalized indicator and scaled in the range between 0 and 100.

Pipruit: And what does it mean – “scaled”?
Commander in Pips: It means that it can’t reach values above 100 and below 0. When we will talk about how it calculates – you will understand why it is in that way. In general stochastic is used for two major purposes:

1. Estimation trend;
2. Estimation conditions of oversold and overbought.

Also Stochastic has so called extreme zones – extreme low zone is 0-25 and extreme high zone is 75-100. These zones are adjustable, so you can appoint not 25/75 but 35/65 for instance or 10/90.

Here is how it looks like – don’t pay much attention to rectangles – we will discuss them a bit later:

Chart #1 | Weekly EUR/USD and (8;3;3) Stochastic

The fast line of stochastic (blue) is called %K, and the slow line (red) is called %D. Also you can see 25/75 extreme zones with horizontal dashed lines. For trading what usually applies to the so-called “Slow Stochastic” that uses two levels of averaging, while “Fast Stochastic” uses just single averaging.

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Lasted edited by : Mar 20, 2016
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