There are two types of Stochastic: fast Stochastic and slow Stochastic. Both have two lines: the fast Stochastic line, called %K, and the slow Stochastic line, called %D. The Stochastic oscillator is designed to oscillate between 0 and 100. Low levels mark oversold markets, and high levels mark overbought markets.
The difference between the slow and fast stochastic indicators is the way that the %K and %D values are calculated. Slow stochastic is based on the moving averages values calculated for fast stochastic and if used for generating trading signals, will tend to generate less signals than the fast stochastic but many traders see the slow stochastic as more reliable.
The default Slow Stochastic settings are:
%K - 5 days
%K slowing periods - 3 days
%D - 3 days
All are just simply moving averages
Using the Slow Stochastic
The way to use the slow stochastic is similar to how the fast is used in that when the stochastic rises above 80 prices are overbought and when they move below 20 prices are oversold
A Bullish Move: %K and %D lines fall below and then rise above the 20, combined with with a %K line cross above the %D line, indicates a potential trend change to the upside
A Bearish Move: %K and %D lines rise above and then fall below the 80 threshold, combined with a %K line cross below the %D line, indicates a potential trend change the downside.
When you are using stochastic with price charts, keep the following factors in mind:
When the %K line nears the 100% or 0% line a big potential move is set to occur – either a significant correction or a trend change.
A divergence is said to have occurred when the price and oscillator trend lines move in different directions. A price reversal could then follow.
Lane referred to a flattened %K or %D line as hinges. A hinge may indicate that the up-trend or down-trend has reached its end and, and that a trend reversal may occur.
When the price has reached 80 or higher, and a divergence has occurred, a crossover is the sell signal and therefore, the sell signal is more reliable when %D has already turned down when %K crosses below %D"."
On the other hand, when the price has reached 20 or lower, and a divergence has occurred, a crossover becomes the buy signal.
No one currency indicator is totally reliable and you need to combine it within a framework of other tools and I find that the best currency trading indicators which work with the stochastic are – the RSI, The MACD and ADX indicators.
If you are a currency trader, the slow stochastic can help you achieve better market timing and accuracy with your trading signals and this indicator should be part of every serious traders education.