Momentum trades are by far the safest and most stable trades to make in Forex. Momentum is based on the theory that a market in motion tends to stay in motion; meaning that if a market has finally gained up enough steam to head in a specific direction then it will tend to remain moving in that direction. Moreover it will take a decent surge of counter pressure to get that market to turn around.
The theory is simple of course, as all theories are, but the practice would be much harder if it were not for one of the most beautiful trading tools called the stochastic indicator. The stochastic is nothing more that a momentum indicator that can give advanced warnings of a market that is weakening in its resolve to continue in its current direction.
How It Works
The stochastic is a set of at least two lines with the title %K and %D. These two lines have differing sensitivities to market fluctuations, with %K being the most sensitive. These lines are plotted on a scale from 1%-100%, with 100% being the highest possible value. There are many ways to use these lines as market triggers but here are the top 2.
First is an overbought and oversold indicator. When the lines on a stochastic indicator move below the 20% range or above the 80% range these are triggers of a market being over bought or over sold. A simple trade would be to purchase when the stochastic breaks out from being below 20% and moves upward. The opposite would be equally true. When the indicator breaks out downward from 80% would be a time to sell short, or exit a long position.
Secondly is trading the crossovers of the lines. As you recall there are two lines in a stochastic indicator (%K and %D). When these lines cross there is good reason to suspect that a market trend is about to change. Now this alone can be a great trigger for trading in or out of a Forex position. However when combined with the ranges mentioned above you have a more sure thing. Waiting till a stochastic falls below the 20% mark AND crosses the other line can yield a high probability trade. The opposite is of course true when the indicators are both in the 80% or better range.
Used as timing indicators, stochastics can be a real help to timing Forex market positions and they are best served when used in conjunction with other indicators, either fundamentals (economic conditions) or technical (classical chart patterns).