Let me ask you…

Have you ever looked at a chart and noticed the Stochastic indicator is overbought.

So, you immediately go short because you think the market is about to reverse.

And here’s what happened next…

The market stalls.

Pause for a while.

…and then it blasts off higher!

Clearly, you got stopped out of your trade and you wonder to yourself…

“Wtf just happened?”

Well, you’re not alone.

That’s why I wrote this Stochastic indicator trading guide to teach you everything you must know about Stochastic, how to use it, how NOT to use it, and why.

Here’s what you’ll learn:

- Stochastic indicator explained: What is it and how does it REALLY work
- The 2 DEADLY mistakes traders make when using Stochastic and how to avoid it
- How to use the Stochastic indicator and “predict” market turning points
- How to use the Stochastic indicator and filter for high probability trading setups
- How to better time your entries with the Stochastic indicator
- When NOT to use Stochastic indicator (hint: it goes against what the “gurus” are telling you)

Or if you prefer…

You can watch this training video below:

**Stochastic indicator explained: What is it and how does it REALLY work**

Now:

Instead of me explaining what the Stochastic indicator is about, here’s what the founder of Stochastic has to say…

“Stochastics measures the momentum of price.

If you visualize a rocket going up in the air – before it can turn down, it must slow down.

Momentum always changes direction before price.” – George Lane

In other words:

The Stochastic is an indicator that measures momentum in the markets.

And for you math geeks out there, here’s the formula to calculate it…

*%K = (Current Close – Lowest Low) / (Highest High – Lowest Low) * 100*

*%D = 3-day SMA of %K*

*Where:*

*Lowest Low = lowest low for the look-back period*

*Highest High = highest high for the look-back period*

*%K is multiplied by 100 to move the decimal point two places*

Are you confused?

Yeah, me too!

That’s why this image below will explain better (using an 8 period Stochastic)…

**Stochastic indicator settings**

Now just a quick one.

The settings on my Stochastic indicator is (20, 1, 1) and it’ll show a single line instead of the traditional 2 lines.

Here’s what I mean:

Now there’s nothing magical about it.

I use 20-period because there are 20 trading days in a month, and a single line is enough to interpret what it means.

Does it make sense?

Great! Then let’s move on…

**2 DEADLY mistakes traders make when using the Stochastic indicator — and how you can avoid it**

This is important.

If you can avoid these mistakes, then you’ll save yourself hundreds if not thousands of dollars in the long run.

They are:

- Going long just because the market is oversold
- Thinking the market will reverse because you spot a divergence

I’ll explain…

**1. You go long just because the market is oversold**

Recall:

The Stochastic is an indicator that measures momentum in the markets.

So, when it’s at overbought level (above 80), it means the market has strong bullish momentum.

And the last thing you’d want to do is “blindly” go short just because Stochastic is overbought.

Here’s why:

As you can see, if you went short just because the market is overbought, it would have been a painful experience.

Because the market can remain overbought/oversold for a long period of time – far longer than your account can withstand it.

Next, let’s move on to the 2^{nd} deadly mistake made by traders…

**2. You think the markets will reverse because there’s a divergence**

*A divergence occurs when the price makes a higher high but the indicator shows a lower high — which means the 2 signals diverge from one another.*

Now…

According to trading textbooks, courses, and etc. they will tell you that when you spot a divergence, it means a reversal is about to occur.

But that couldn’t be further from the truth.

Here’s an example:

As you can see, there’s a divergence but the market didn’t reverse.

In fact, it continued to head lower for quite a while.

**Now at this point…**

You’ve learned the 2 biggest mistakes traders make when using Stochastic and how to avoid it.

Now you’re probably wondering:

“So, what is the correct way to use the Stochastic indicator?”

Well, that’s what I will share in the next section.

Read on…

**How to use the Stochastic indicator and “predict” market turning points**

If you haven’t realized by now…

The reason why traders fail with Stochastic is because…

You don’t use it in the context of the market.

You’re probably thinking:

“What does it mean?”

Simple.

Trade with the trend — and not against it.

If you look at the earlier examples, most of the common mistakes can be avoided if you’re not trading against the trend.

Make sense?

Great!

Then let’s see how you can adopt this principle and use Stochastic to “predict” market turning points.

Here’s how…

- If the price is above 200-period moving average (MA), then look for long setups when Stochastic is oversold
- If the price is below 200-period moving average (MA), then look for short setups when Stochastic is overbought

Here’s an example:

Now…

This doesn’t mean you “blindly” go short when Stochastic is overbought.

But it can help you anticipate where the pullback might end, so you can better time your entry and trade with the trend.

Can you see how a simple tweak makes a BIG difference?

Great!

Moving on…

**How to filter for high probability trading setups with Stochastic indicator**

I’m not sure about you.

But whenever I put on a trade, I want to know where I am in the “big picture”.

Why?

Because if you want to find high probability trades, then you want to be trading with the higher timeframe trend — and not against it.

So how do you do it?

Well, you can use the Stochastic indicator to filter your trades.

Here’s how…

Let’s say you want to go short on the 1-hour timeframe.

But before you do so, check the daily timeframe and see where you are in the “big picture”.

You want to make sure the daily timeframe is not in an uptrend with Stochastic oversold.

Because that’s where the market is likely to rebound higher — and you don’t want to be short.

An example:

Most of you might want to go long based on the chart below…

But…

If you look at the higher timeframe, you’ll realize something is not right.

The higher timeframe is in a downtrend and Stochastic is at overbought level.

So chances are, the market is likely to continue trading lower, and you don’t want to be long.

Can you see how it works?

Great!

**How to use the Stochastic indicator to better time your entries**

Now unlike chart or candlestick patterns where the entry can be subjective, the Stochastic indicator doesn’t give you that problem.

That’s because there’s no discretion for the entry.

It’s either YES you enter, or NO you stay out.

So if you’re the type of trader that is always unsure whether you should pull the trigger, then this entry technique is for you…

Here’s how…

- If you have a long bias, then go long when the Stochastic line crosses above 20
- If you have a short bias, then go short when the Stochastic line below above 80

Here’s an example:

Now, what does this means?

Recall:

The Stochastic indicator measures momentum.

So, when you see the Stochastic crossing above 20, it’s telling you bullish momentum is stepping in (and vice versa).

And one important thing:

Don’t mistake this as a trading strategy because it’s not.

Rather, it’s an entry trigger to get you into a trade.

A BIG difference.

**Why you don’t need to use Stochastic indicator in a range market**

Now:

If you search the internet, books, courses, and etc, they will tell you the best time to use the Stochastic indicator is in a range market.

Why?

Because you can wait for the price to be overbought before shorting (and vice versa)

An example:

And from the looks of it, it seems that Stochastic indicator can pinpoint the tops/bottoms of a range with deadly accuracy.

But here’s the thing:

Do you REALLY need a stochastic indicator to do so?

Nah.

Because all you need to do is…

Short Resistance.

And voila! You get the same result.

Here’s what I mean:

As you can see… you’ve accomplished the same thing as what Stochastic did — but with less clutter on your charts.

Does it make sense?

Awesome!

**Conclusion**

So here’s what you’ve learned today:

- The stochastic is an indicator that measures momentum
- Don’t go short just because Stochastic is overbought because it can remain overbought for a long time
- Spotting a divergence doesn’t mean the market will reverse. It fails more often than not in a trending market
- In a downtrend, overbought level on Stochastic can help you time when the pullback might end (and vice versa in an uptrend)
- The Stochastic can serve as an entry trigger to go long when it rises above 20 (and short when it cross below 80)

Now here’s my question for you…

How do you use the Stochastic indicator?

Leave a comment below and share your thoughts with me.

Awesome!, Handsome

Cheers

Is there an indicator that tells you market is ranging?

You can use oscillators like RSI or Stochastic.

But you don’t need them as your eyes can do it too.

Good lesson Rayner thank you very much.

You’re welcome, Fabio.

Thank You for your lesson Mr Rayner…

My pleasure!

As clear as a bell. Thanks Rayner.

I’m glad to hear that, Van.

Very interesting lesson . Thank you

Cheers

Rayner you are an Iumination to your generation and beyond. i have struggled to understand this stochastic concept for a while now. but today after reading and watching this material, am good. and have started making profit instantly. more wisdom to you.

Awesome to hear that!

Could please share how you simply use your stochastic profitably..? Thanks

Rayner- you are god-sent. It could not be explained any simpler. Sharing this and many previous videos only shows the caring side of you. Thanks.

Thank you for your kind words!

How can you tell when a ranging market is about fo breakout of its range

This post will help… https://www.tradingwithrayner.com/support-and-resistance-trading-strategy/

Thank Rayner bunch it was very helpful and insightful. thanx again

Thank you for explaining STS further 🙂

You’re welcome!

You talk about everything but how to determine where to exit?

Thanks!

Robin

These post will help with your exits…

https://www.tradingwithrayner.com/set-stoploss/

https://www.tradingwithrayner.com/2-how-to-know-when-is-the-best-time-to-exit-your-trades/

Rayner you are genious but please let me know complete about divergence

I believe you can find tons of information on Google.

I printed out this article and brought on my work. I want to master in stock trading even if i have a full-time job here in Philippines. I keep reading on it even my co workers laugh at me.thank you rayner

You’re welcome, Janel. Keep on pushing!

Nice one Rayner! Pls can i get a PDF of this?

I don’t have it.

I’m new to this so I’m still researching about these indicators. But I think it would be best to use it together with other indicators like candle stick patterns, moving averages, support and resistance, and the like. Is that a good way to use stochastics? Thanks a lot sir Rayner.

There’s no best way to use an indicator.

What’s important is to understand how it works and then complement it with your own trading approach.

Hi Rayner, Thank you very much. this is very helpful for me or us newbie in trading fx or stock. You are inspiration just like your fried from the Philippines JC Bisnar. Im from philippines and big fan and a follower of you in investa and fb. Again, thank you very much.

You’re welcome, Nobie.

I appreciate the kind words!

Awesome. I Got it now! Thank you so much sir.

You’re welcome!

Thanks rayner

,do this strategy work in intraday?

I mean stochastic of 20 period will applicable in 5min,15min or 1days???

The concept can be applied the same.

Thanks a lot, Rayner! This is really helpful, more than you’ll ever know.

Awesome to hear that, Alex.

I use 5,3,3. Sir what is the difference between 5,3,3 and 20,1,1

The lookback period and the smoothing of Stochastic.

Thanks a lot for enlightening me. Was following wrong path of buy or sell when overbought/oversold. Will try this soonest.

Sure, let me know how it works out for you. cheers

Thanks a million, Rayner

I hope what I’ve read today is gonna help me a lot when trading.

Happy New Year!

Awesome, happy new year!

Thanks Rayner for sharing your professionalism with us !

When checking time frame, what I notice is that, H1 is trending downwards and EMA is above which is what we are looking for, but on D1 is trending upwards and EMA is bellow, which confuses potential pull-back entry.

Which time frame should we follow, H1 or D1 ?

Also, do we need to take into consideration W1 an MN time frames ?

Many Thanks for your help !

HAPPY NEW YEAR 1

I suggest following the signal on your trading timeframe.

Anything below it is noise to you.

To determine what best time frame to use on Monday create EMA 133 or SMA 200 from your chart I prefer Exponential Moving Average 133 by Friday compare you EMA 133 from 15min to 4H chart you will notice the market support and resistance were respecting more the 30Min & 1H chart.

Best time frame to trade 1H and your pull back 30Min. There 4H and D1 serve as mirrors for a bigger picture

Thank you for sharing, Dokta.

thanks, very clear and well presented

I’m happy to hear that, Mimi.

An excellent summary of the stochastic indicator however I do use the two lines it has definitely shown me that when it’s over 85% and they sometimes touches a hundred that is a rally

Thanks for sharing, Carl!