Stochastic Oscillator is one of the indicators that many of the professional traders are strictly dependent on it. However, when novice traders try to copy these professional traders and add this indicator to their charts, they lose more instead of having more winning positions.
Stochastic Oscillator can be a big money sucker if you don’t know how to use it. But it is a good indicator and helps you to filter out many of the false breakouts and reversal setups if you know how to use it.
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A Simple Formula to Use Stochastic Oscillator Efficiently
I have a simple formula if you like to use Stochastic Oscillator on your charts:
Don’t use Stochastic Oscillator to go against the trends and to take the reversal trade setups. Use it to follow the trends and to take the continuation trade setups.
It is very easy. Forget about entering the market when Stochastic Oscillator is moving between the 20 and 80 levels. Enter the market only when it is on the overbought or oversold area.
Because you will follow the strong movements and trends if you enter the markets when Stochastic Oscillator is on the overbought or oversold area, but the market’s direction can be anyone’s guess when Stochastic Oscillator is moving between the 20 and 80 levels.
Combine this with a signal on the price charts and then you are done. For example, when a resistance line or level breakout forms on the price chart and at the same time Stochastic Oscillator is on the overbought area, that is a long trade setup. Or when a strong bullish signal forms by the candlesticks while Stochastic Oscillator is on the overbought area, again you have a long trade setup.
It is the same with going short. You can go short when a support line or level breakout forms on the price chart and at the same time Stochastic Oscillator is on the oversold area.
And, do not enter when Stochastic Oscillator is between the 20 and 80 lines.
This is the safest way to use Stochastic Oscillator. If you do so, you change this indicator from a money sucker to a strong indicator to follow the trends.
As you see on the below chart, the support or resistance breakout worked and the market moved accordingly only when Stochastic Oscillator was on the oversold or overbought areas respectively.
But in cases like #4, the price moved the other way when the breakout formed and Stochastic Oscillator was between 20 and 80 levels.
As you can see at the right side of the below chart, Stochastic Oscillator can be a great indicator in following the strong trends. Even if the price doesn’t move strongly after a trade setup (e.g. case #1), at least it gives you the chance to move your stop loss to breakeven before the price goes against you, but when Stochastic Oscillator is moving between the 20 and 80 lines, the price goes against you right after you enter the market.
Study all the cases on the below chart: