The Stochastic technical indicator tells us when the market is overbought or oversold.
The Stochastic is scaled from 0 to 100.
When the Stochastic lines are above 80 (the red dotted line in the chart above), then it means the market is overbought.
When the Stochastic lines are below 20 (the blue dotted line), then it means that the market is possibly oversold.
As a rule of thumb, we buy when the market is oversold, and we sell when the market is possibly overbought.
Looking at the currency chart above, you can see that the indicator has been showing overbought conditions for quite some time.
Based on this information, can you guess where the price might go?
If you said the price would drop, then you are absolutely correct!
Because the market was overbought for such a long period, a reversal was bound to happen.
Many forex traders use the Stochastic in different ways.
But the main purpose of the indicator is to show us where the market conditions could be possibly overbought or oversold.
Keep in mind that Stochastic can remain above 80 or below 20 for long periods of time.
So just because the indicator says “overbought” doesn’t mean you should blindly sell!
The same thing if you see “oversold”, it doesn’t mean you should automatically start buying!
Over time, you will learn to use the Stochastic indicator to fit your own personal trading style.
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