Stochastic Overbought and Oversold Levels
Stochastic oscillator is used to look for overbought/oversold signals. Overbought levels are above 80% level and oversold levels are below 20% level.
The key is to not only look at stochastic when the %K or %D lines touch or cross overbought/oversold, but also when they cross over and back through these levels.
Just as with other momentum indicators such as RSI the stochastic can stay inside the overbought and oversold levels for some time. When this indicator stays within these levels for a long time it indicates strong upward Forex trend (overbought) or strong downward Forex trend (oversold).
When the lines cross back below or above these levels it is usually a good indication of an upcoming trend reversal.
One can look for further signs to make the oversold or overbought levels more reliable if:
- Before Buying, the %K and %D lines turn upward from below 5%.
- A reading that is floating near 5% means that bears are in control and there is selling of the currency pair. A trader should wait for the Stochastic Oscillator to move back above 5% as a sign that the selling pressure is easing.
The Buy signal is confirmed when the stochastic oscillator moves above oversold, then after a while returns to oversold but this time moves up immediately without staying at the overbought.
- Before Selling, the %K and %D lines turn down from above 95%.
- A reading that is floating above 95% means that bulls are in control and there is buying of the currency pair. A trader should wait for the Stochastic to move below 95% as a sign that the buying pressure is easing.
- The sell signal is confirmed when the stochastic moves below overbought, then after a while returns to overbought but this times moves down immediately without staying at the overbought.
Looking at different time-frames when using oversold and overbought levels can also help to determine the correct entry strategy. The main theory is to trade with the trend. Always double check the trading signals with the longer term stochastic to confirm trading signals on the shorter time-frame periods.