The Stochastic oscillator is designed to oscillate between 0 and 100. Low levels mark oversold markets, and high levels mark overbought markets. Overbought means too high, ready to turn down. Oversold means too low, ready to turn up.

When the Stochastic oscillator is low, look to capitalize on peoples fears by buying. When the Stochastic oscillator is high, look to capitalize on peoples greed by selling. Buying when the Stochastic is low is emotionally challenging because you will be afraid to buy the terrible looking chart. Conversely, selling when the Stochastic is high is emotionally challenging because the market will look great and you’ll feel greedy, like you could make even more money.

New traders mess up by trying to over simplify trading. They pick just one indicator and use it because it’s all they can conceptually understand. Don’t do this. The Stochastic indicator needs to be used with other indicators. Why? Consider this. In a sudden buying frenzy, the Stochastic becomes overbought too quickly and will give a premature sell signal. In sudden panic selling, the Stochastic becomes oversold too quickly and will give a premature buy signal. Always use the Stochastic with other indicators.

Should a trader wait for the Stochastic indicator to turn up to recognize a buy signal? Should he wait for it to turn down to recognize a sell signal? Not really, because by the time the Stochastic indicator turns, a new move is usually under way. If you are looking for an opportunity to enter, as soon as the Stochastic indicator reaches an extreme you enter.

Go long when the Stochastics traces a bullish divergence, that is, when prices fall to a new low but the indicator makes a more shallow low. Go short when the Stochastics traces a bearish divergence, that is, when prices rise to a new high but the indicator ticks down from a lower peak than during the previous rally. In an ideal buying situation, the first Stochastics low is below and the second above the lower reference line. The best sell signals occur when the first top of the Stochastics is above and the second below the upper reference line.

Do not buy when the Stochastics is above its upper reference line and do not sell short when it is below its lower reference line. This is probably the most useful way to use the Stochastic. Moving averages are better than the Stochastics at identifying trends, MACD-Histogram is better at identifying reversals, channels are better at identifying profit targets, and the ADX is quicker at catching entry and exit points. The trouble with them is that they give action signals most of the time. The Stochastic identifies no trade zones.