Hello and welcome to CantosCharts Masterclass. I'm Sandy Jadeja, Chief Market Strategist for CMS FX. And as always, we're going to give you some lessons in technical analysis, but they're simply for education and information purposes only.

Today we're going to take a look at a very popular indicator called the stochastic indicator. And many traders use stochastic indicator to pick tops and bottoms. The one thing that I will tell you is that there are not any indicators out there - not as far as I know yet - that actually does pick tops and bottoms. This is simply used to confirm maybe there's a possibility of a market high or a market low coming, but of course we'll take a look at more detail how to use the stochastic indicator.

So, the indicator is a momentum oscillator. That's the most obvious thing that we'll find out when we take a look at a closer look. But it indicates that the location of current close relative to the high-low range, and that's over a given time period. There's a crossover method which can also be utilised and as I say, it does not pick tops and bottoms, so let's try not to delve too much in picking the turning points.

Now, here, we can see this particular indicator and there are two lines here. There's the red line and there's a dotted line. So again, it looks like a moving average crossover, but essentially it's an oscillator. And there are two ways of looking at it. The dotted line is the slower line, and the red line here is the faster line. So we can say that one line is a signal versus the other. And it's plotted on a scale ranging from zero to 100, but the way I tend to look at the stochastic indicator is by setting a range. And we will take a look at the 20 and also the 80 area.

So essentially what we're saying is when the stochastic comes down to the 20 area, there's a possibility that the market could be oversold. If the oscillator then goes into the region of 80 or above, there's a possibility that the market could be considered as being overbought or too expensive.

And that doesn't mean to say that as soon as the market or the oscillator enters into this zone here the market will turn. And vice versa. It doesn't mean to say that if the oscillator's in this region here, that it's going to turn higher. That is not the way the oscillator is used.

Here, for example, we notice that from point 1 to point 2, the oscillator had indeed crossed and gone higher. But notice between 2 and 3, the oscillator continued to remain in the overbought area, and yet the market continued to go higher. That is a classic divergence signal there. So in other words, although at this point here, it's indicator that the oscillator has crossed and it's come below at this point over here, below the 80 line, the market continuing higher.

And as I said before, price is the leading indicator, not the oscillator or the indicators. And therefore, one could have looked at this and says, right, this is actually pointing as if it's going to go down, but the market's going higher. Look for the breakout above the recent highs as the stronger signal rather than this one here.

And notice at point 3 we did get a crossover, and the oscillator came below the 80 line, and we had a second - or we could say a double top - on the oscillator here. And the market actually continued to go sideways.

Now if you would have taken these signals here to have gone short, you wouldn't really have gotten very good results. Eventually, the oscillator continues to go down, but we only had a short pullback.

What is this telling us? Straightaway we can say that the trend in this market is actually quite strong, and this is where the oscillators and technical indicators fail for traders.

Again, notice here we are continuing to reach into the 80 area. The market continues higher. And then we see a strong crossover and a breach below the 80 area, and right down into the oversold area. A nice little pullback. That was a 6 per cent pullback over there, so that was quite a nice move.

And then again we see a crossover back above the 20 line and a crossover on the stochastic and then the market again trends higher between 4 to 5.

So if this is a bull market, maybe we could say to ourselves, 'Let's ignore all sell signals here, and only take the buy signals as and when they come.' You would generate much better results by taking that type of strategy.

Now here, this is the weekly chart. Again, let's take a look at this. Between 1 and 2 we had a very nice signal on the downside. Between 2 and 3, however, the oscillator was trending higher. Meanwhile, the market itself was going sideways with a new low at point 3. There's a clear divergence there.

That's telling us there's an imbalance between the oscillator - the indicator - and the market itself. And again, I would rather follow price than the oscillator.

Again we have a crossover. We didn't quite reach into the sell zone indicated by the blue lower line. We did have a crossover here. And once again, the market trends higher. And at point 4, the oscillator shows up there's a possibility that we might see a downtrend. And yet again, this market continues higher, taking out the recent high.

In our earlier lessons we talked about buying the breakouts at the highs, and that's exactly where that methodology would have proven to have been a much better way of trading the market.

Here again, the oscillator is in the overbought area. Right now we have seen a crossover and trading below the 80 area and yet again the market's trading sideways. Which one is stronger? The oscillator or the market? I would vote with the market.

So always follow the market and use the oscillator as really a confirmation more than anything else, rather than using it as a buy and sell signal indicator.

So, trading with the stochastic indicator, I would suggest using the 13/8 period, or the 8/5 settings for short-term 8/5s, longer term 13/8, and use a 20 and 80 as the extreme levels. Look at the larger-degree timeframe for your trend, and then the lower-degree timeframe for your entry and exits to enter the market.

And of course, we can use the stochastic with a combination of other methods such as moving averages. The stochastic indicator is not the Holy Grail as some traders view it as, but it is useful for identifying extreme levels but can fail in very strong trending markets.

Now, trading with the RSI is another popular indicator and that's something we're going to take a look at in the next lesson.

In the meantime, have a great trading week. This is Sandy Jadeja with CantosCharts Masterclass.