The Stochastic is another indicator that helps us determine where a trend might be ending. The stochastic has two lines that cross each other to give a sell or a buy signal.
By definition, a Stochastic is an oscillator that measures overbought and oversold conditions in the market. In a market trending up, prices close near the high, and in a market trending down, prices close near the low.
How to Trade Using the Stochastic
The Stochastic is scaled from 0 to 100 and like earlier established, it tells us when it thinks the market is probably overbought or oversold.
When the Stochastic lines are above 80 (the overbought dotted line in the chart above), then it means the market is overbought. When the Stochastic lines are below 20 (the oversold dotted line), then it means that the market is oversold.
As a rule of thumb, we buy when the market is oversold, and we sell when the market is overbought.
Looking at the chart above, you can see that the Stochastic showed overbought when it crossed that dotted line above, based on this, if you sold the pair from there, your decision would be accepted as good because after then, the price started going down, in other words when the price is overbought, sooner or later a reversal move will take place.
The same is true when stochastic shows an oversold reading. If you bought the pair after an oversold reading, chances are high you would catch the bull run that proceeds after the oversold reading. The chart above explains it.
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