Learn how to effectively use the stochastic oscillator to measure momentum and predict market turning points while avoiding common mistakes in forex trading. It is important to not forget to look at higher time frame trends and to use the oscillator in conjunction with them. The video also includes a demonstration on Smart Charts using the AUD/USD pair to show when to go long or short.

Mastering the Stochastic Oscillator

Introduction

The stochastic oscillator is undoubtedly one of the most used and abused forex indicators in the market. As a crucial measure of momentum, it is important for traders to understand what drives the indicator up and down. In this video, we will examine the usage of the stochastic oscillator and explore how it can help predict market turning points in a pullback.

Mistakes to Avoid

Before diving into the usage of the stochastic oscillator, it is important to avoid two deadly mistakes. Firstly, blindly going short when the oscillator is overbought and long when it is oversold will only lead to a consistently bleeding trading account. Secondly, assuming the market will reverse just because you spot a divergence is a mistake.

Using the Stochastic Oscillator to Predict Market Turning Points in a Pullback

A pullback is a counter trend movement, and traders can use the stochastic oscillator to time when a pullback will end. If the price is above the 200 period moving average, this signals a long bias. In this scenario, traders should look for long setups when the oscillator is oversold, and price is above the 20 period moving average. Conversely, if the price is below the 200 moving average on the chart, traders should look for short setups when the oscillator is overbought, i.e., crossed through the 80% zone and is now crossing back down through it.

Filtering High Probability Trading Setups

To filter for high probability trading setups, traders should use the oscillator itself and compare it to the higher timeframe trend. Successful traders commonly use hourly charts and the daily chart to determine the higher timeframe trend. Looking at the bigger picture helps traders avoid tunnel vision and mistakenly assume that the oscillator signals a long trade just because the price is above the 200 period moving average.

Putting the Theory into Practice

To better understand how the stochastic oscillator works, we can use Smart Charts to see it in action. Looking at the AUD/USD hourly chart, we can see when to go long and when to go short by studying the overbought and oversold zones. However, to determine the overall picture, we must first look at the higher timeframe trend. In this case, the daily chart shows that the AUD/USD is in a downtrend. Therefore, traders should only take short positions that are consistent with the market’s overall trend.

Conclusion

While many traders use the stochastic oscillator, few truly understand it. By avoiding the two deadly mistakes and using the oscillator to predict market turning points in a pullback, we can filter for high probability trading setups. However, to truly master the stochastic oscillator, it is important to factor in the higher timeframe trend to avoid tunnel vision and stay on top of the market.