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# Best Stochastic Oscillator Settings & Trading Strategies

The Stochastic Oscillator indicator is one of the most powerful and profitable indicators in technical analysis and can be applied in the forex market, stock market and just about any market. However, most people tend to use it wrongly because they do not know what the best stochastic settings are and usually stick to the common 5 3 3 stochastic settings. They are also unaware of the *secret *profitable stochastic oscillator trading strategies that can be employed in any trading horizon, especially day trading and scalping. In this article, I will show you how to use the Stochastic Oscillator in ways you’ve never imagined before.

## Forex Stochastic Oscillator Strategy

The Stochastic Oscillator, like the RSI, simply fluctuates between 0% and 100% with it commonly being used to identify overbought and oversold areas to trade off. The industry standard is to use 20% and 80% as these levels. 20% means price is about to bounce up and 80% means price is about to drop. However, while there is some logic in this, it is **completely wrong**. This is what the big players want you to believe – I will now show you the ways in which the big players (banks, hedge funds) use the Stochastic Oscillator to trade profitably.

When used correctly, the Stochastic Oscillator can help you identify the following :

- Hidden support and resistance levels (horizontal)
- Hidden support and resistance levels (diagonal)
- Hidden breakout levels
- Bearish divergence reversals
- Bullish divergence reversals

We’ll cover all of this in this article and while we’re at this, it’s also worth taking a look at **how to use RSI in a trading strategy** along with finding the **best support and resistance levels** as these two other techniques can combine really well in providing you with an amazingly powerful trading strategy.

## Best Stochastic Settings

Now one of the key debating points when using the Stochastic Oscillator is what exactly is the best stochastic settings? Fast stochastic vs Slow stochastic, or maybe even full stochastic? Do we use 5, 10 or a 100 period in the settings? Well, let me give you the definitive truth in picking the best stochastic settings now :

The best choice is a specially adapted slow stochastic because it filters out a lot of the choppy noise in the fast stochastic. I’ve searched high and low for an adapted slow stochastic but can never find it anywhere. Hence, I took it upon myself to code the TFA Stochastic Indicator which has some proprietary modifications to the existing stochastic indicator. It does a better job in filtering out all the noise caused by the normal fast and slow stochastic indicators.

A lot of people prefer to use the fast stochastic because it moves faster (duh) and hence generate more trading opportunities. But the thing is, especially in the forex world, being fast and furious often leads to going bust. Slow and steady is the way to go. Of course, we combine this with our other leading indicators to give us optimum trading opportunities since relying on stochastic alone is never enough (we’ll touch on this later).

Next, the best period to use is not just one period, but to cycle between a range of periods to find which ones the market is adapting to best as the market is so smart that it often requires us to think out-of-the-box just to see what it is up to. Hence, instead of using the standard period of 5, we use a range of periods mainly 13, 21, 34 and 55. I will show you in examples later how we managed to predict the market’s movements with these unique settings.

## Stochastic Oscillator Strategy : Hidden Support and Resistance Levels (Horizontal)

One of the more powerful features of the Stochastic Oscillator is its ability to pick bottoms and tops. Now most people use a simple 20% horizontal line as support and 80% horizontal line as resistance. While this is nice, it is also **wrong**.

The trick is to look for hidden support and resistance levels based on what the market is providing you. In the examples below, I will show you how this is done.

### EURJPY Example :

In the above example, you can see that we are not using 20% as the support on our Stochastic Oscillator, instead, we observed how the market tends to bounce off the 12% level. From there, we can tell that the 12% support level is a much more important level which we can use to trade from.

Since price is right at our buying entry level (determined by our **best support and resistance indicator**) and Stochastic is right on 12% support, it would serve as a good entry level.

The picture above is what happened a day after we decided to buy right at support. Price has bounced off perfectly as expected and Stochastic has bounced off the 12% support level perfectly as expected too.

The trick then is to look out for hidden levels of support and resistance and not just trust the 20% support that the crowd follows.

Below is another example of using the Stochastic Oscillator to perfection with hidden support levels.

### AUDNZD Example :

In the above example, we can see how price tends to bounce off the 4% support level on the Stochastic Oscillator. We’re also using a period of 21 as it is able to best match recent price movement. Price is right on horizontal support and bollinger band support which signals a potentially good entry.

We look for further confirmation in our Stochastic Oscillator and we can see that price is right above 4% support and displaying bullish divergence which is a strong sign that price is going to bounce off soon.

In the above picture, you can see how Stochastic bounced perfectly off our 4%* hidden* support and along with it, price also bounced perfectly to reach our profit target. This is another brilliant example of the unknown stochastic trading strategies that I hope to make known to everyone. Don’t just drink the kool aid that the crowds are doing – think outside the box, keep an open mind and you’ll notice that the best stochastic strategy is not a fixed one, but a highly adaptive one like we are showing you.

### AUDNZD Example :

In the above picture, you can see how Stochastic bounced perfectly off our 4%* hidden* support and along with it, price also bounced perfectly to reach our profit target. This is another brilliant example of the unknown stochastic trading strategies that I hope to make known to everyone. Don’t just drink the kool aid that the crowds are doing – think outside the box, keep an open mind and you’ll notice that the best stochastic strategy is not a fixed one, but a highly adaptive one like we are showing you.

### So what does this teach us?

This should teach us three key lessons :

- Do not stick to the standard 5 3 3 stochastic settings. It is also not necessary to use a fast or full moving average as a slow stochastic oscillator is sufficient. Swap between the 13, 21, 34, 55 settings and see if you can find horizontal support levels that line up well on the stochastic oscillator that also lines up well on price bounces.
- Do not use the standard 20% as support and 80% as resistance stochastic setting. Instead, do not be afraid to draw different horizontal lines and see which ones catches the most bottoms/tops and sees price reacts off the equally well too. This is finding your hidden support and resistance levels.
- If you see bullish or bearish divergence on Stochastic versus price, even though the stochastic value may not be right on your support (like in the AUDNZD 4% support example above), it is an early signal that we’re going to see a bounce soon and can serve as a good confirmation.

So go forth and practice this to perfect your craft. Many people use an RSI Stochastic strategy (which is basically combining both to provide further confirmation) to further improve their profitability considerably.

## Stochastic Oscillator Strategy : Hidden Support and Resistance Levels (Diagonal)

Wait.. you mean you can use diagonal lines on the Stochastic Oscillator indicator to find support and resistance too? That’s madness! As amazing as that sounds, it is entirely true. This technique is a little bit more difficult compared to our earlier method on identifying horizontal support and resistance levels but when you do master it, you’ll start seeing things in a completely different light.

### AUDNZD Example :

In the above picture, we can see very clearly how price has been reacting off the 90% resistance line on the stochastic indicator multiple times. However, there’s a diagonal ascending line that is supporting it. When the stochastic finally makes a bearish exit of the diagonal ascending line (meaning it breaks below it), it triggers a further bearish move down from here.

In the example above, it’s clear to see how price has dropped perfectly as expected after the bearish exit of the diagonal ascending support line from the stochastic indicator.

This is a perfect example of using the diagonal lines on stochastic indicators to predict when bearish moves would occur. Such stochastics trading strategies are definitely more advanced and require more practice to easily see where the ascending or descending diagonal lines are and to forecast how a break of these lines would be a good signal of a bullish/bearish move.

What we usually look out for in bearish scenarios are :

- Is there an
**ascending support line**on the stochastic indicator? - Does price react well to the ascending support line (eg. every time stochastic touches the line, price similarly bounces up)
- Did the stochastic break the ascending support line from the top down? If yes, this would be a good pre-signal that we’re seeing a bearish move soon.

What we usually look out for in bullish scenarios are :

- Is there a
**descending resistance line**on the stochastic indicator? - Does price react well to the descending resistance line (eg. every time stochastic touches the line, price similarly drops)
- Did the stochastic break the descending resistance line from the bottom up? If yes, this would be a good pre-signal that we’re seeing a bullish move soon.

### EURJPY Example :

In the above example, the key thing for us to focus on is how whenever stochastic touches the descending resistance line, there is a nice reaction on price. We expect price to continue dropping as stochastic continues to slowly rise to test the descending resistance line.

We can see in the example above how price rose to our selling area perfectly as expected and from there, dropped perfectly to our take profit target. This is the perfect example of how we can use the descending resistance line on our stochastic indicator to forecast when potential price reversals are about to happen.

This can of course be applied to ascending/descending support/resistance lines too. If stochastic is above an ascending support line, it means that there is a possibility of a potential bounce. As a rule of thumb, for bullish scenarios, we usually look for **ascending support lines** on our stochastic indicator. For bearish scenarios, we look for **descending resistance lines** on our stochastic indicator. I usually prefer it if price has at least reacted off our ascending/descending lines at least 2 to 3 times prior as it would show that that is a valid line to consider.

## Stochastic Oscillator Strategy : Bearish divergence and Bullish divergence

Now we move on to the art of divergence. It is a very simple concept and is usually used in conjunction with the above mentioned 2 stochastic oscillator strategies (horizontal support and resistance, diagonal support and resistance).

Before we begin, I recall when I first tried to understand bullish and bearish divergence, I had a lot of problems understanding what swing high and swing lows are. To that tune, I have put together a neat video identifying what swing highs and swing lows are so we can move forward in this tutorial with ease.

A stochastic bullish divergence is very simple :

1. Price makes a lower swing low

2. Stochastic makes a higher swing low

Think of it as the stochastic indicator is the ‘true’ indicator. It is making higher swing lows (meaning the market is rising) but yet price is making lower swing lows – something is not right and the stochastic oscillator has detected this particular **divergence. **

A stochastic bearish divergence is simply the opposite :

1. Price makes a higher swing high

2. Stochastic makes a lower swing high

When this happens, what the stochastic is saying is : hey buddy, we’re supposed to be making lower swing highs (in essence, a descending market) but you’re making higher swing highs, something is wrong with this **divergence.**

### AUDNZD Example :

In this example, we can see a bearish divergence in progress. It’s similar to the example above but this time we highlight that on top of seeing horizontal resistance on stochastic, we are seeing a bearish divergence too and this always gives us further confirmation of an impending drop.

Why this trade was such a high probability of success trade is because there are so many factors coming in :

1. Price is on channel resistance

2. Price is testing a previous swing high

3. Stochastic is reacting off horizontal resistance

4. Stochastic has made a bearish exit of diagonal line

5. Stochastic is displaying bearish divergence

**5 factors!** This is a perfect example of how you ensure you make high probability trades.

The result from that is price dropping perfectly from that level as seen in the picture below :

## Conclusion

So there we have it. A complete guide to learning how to trade using stochastics. This system, when combined with our **RSI trading strategy** and our **support and resistance strategy**, produces some of the most profitable and accurate trades. Always remember that the more factors you can combine to your advantage, the higher chances your trade would be profitable.

I hope you also realize that there’s isn’t a single best stochastic setting for swing trading or scalping or day trading, rather, it’s a combination of settings whether we toggle between the 21, 34 or 55 period and whether we look out for horizontal lines or diagonal lines. It’s an art and once you’ve trained yourself long enough, you’ll start to see these hidden patterns with much more ease.

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