When trading knowing overbought and oversold zones helps us immensely identifying reversals with ease. To do so most of the traders use the RSI indicators. The problem with rsi is that it is a slow indicator. If you have traded the the rsi then you will surely know that rsi signals are sometimes very late and rare.
So what should we do to get faster and regular signals. The answer is using the stochastic indicators.
What is the Stochastic Indicator ?
It is a short term momentum indicator that is very similar to the RSI indicators. The basic premise of the stochastic is that is compares the current close to the highest and the lowest closes during a particular time period. So if we choose a 10 period stochastic it will show where the current candle is in the range of the last 10 candles.
On the indicators here we have two lines:
- Blue line is a % K line. It is the actual stochastic line. It shows us the actual value.
- Orange line is the %D line. It is simply the 3 EMA moving average of the %K blue line.
Traders often use the cross overs of these two lines to determine the exit and entry points.
This indicator is also used to identify the overbought and oversold zones in the market. When the stochastic goes above the 80 level.
It is regarded as an overbought area.
It is expected that price will make a short term down move.
Similarly when it goes below 20 level:
It is considered as oversold zone.
We here expect a short term up move.
Yellow line: 21 period ema
Red line: 50 period ema
Up trend : 21 period ema above 50 period ema, sloped up wards
Down trend: 21 ema below the 50 period ema, sloped down wards
Another characteristics of moving average – it acts as a dynamic levels of support and resistance in the trending market.