Stochastic Oscillator is one of the indicators that many professional traders are strictly dependent on. 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 false breakouts and reversal setups if you know how to use it.
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 trends and to take the reversal trade setups. Use it to follow trends and to take continuation trade setups only.
How?
It is very easy. Forget about entering the markets when Stochastic Oscillator is moving between the 20 and 80 levels. Enter the market only when it is on the overbought or oversold area.
Why?
Because you will follow 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 price charts and then you are done. For example, when a resistance line or level breakout forms on price chart, and at the same time Stochastic Oscillator is on the overbought area, this is a long trade setup. Or when a strong bullish signal forms by the candlesticks while Stochastic Oscillator is on 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 price chart and at the same time Stochastic Oscillator is on oversold area.
And, do not enter when Stochastic Oscillator is between 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 into a strong indicator to follow the trends.
As you see on the chart below, a support or resistance breakout worked and the market moved accordingly only when Stochastic Oscillator was on oversold or overbought areas respectively.
But in cases like #4, 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 chart below, 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, price goes against you right after you enter the market.
Study all the cases on the chart below:
