How to Use the KDJ Indicator in Forex Trading?

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I. Principle of the KDJ Indicator

The stochastic indicator KDJ is generally based on statistical principles, calculating the immature random value RSV for the last calculation period using the highest price, lowest price, and closing price of the previous calculation period, as well as the proportional relationship between these three. Then, using the method of smooth-moving average lines, the K, D, and J values are calculated and plotted as a curve to study the trend.

The KDJ stochastic indicator is calculated using the highest price, lowest price, and closing price as basic data. The resulting K, D, and J values form points on the coordinate system of the indicator. Connecting countless such points forms a complete KDJ indicator that reflects the trend of price fluctuations.

It mainly uses the true amplitude of price fluctuations to reflect the strength of price trends and phenomena of overbuying and overselling, issuing buy and sell signals before prices rise or fall.

In its design, it mainly studies the relationship between the highest price, lowest price, and closing price, and also integrates the concepts of momentum, strength indicators, and some advantages of moving averages, thus allowing for a rapid, efficient, and intuitive analysis of the market.

The KDJ stochastic indicator first appeared in the form of the KD indicator, which was developed based on the Williams %R indicator. However, the Williams %R only judges overbought and oversold phenomena and has only a directional concept.

The KDJ indicator integrates the concept of speed from moving averages, forming a more accurate basis for buy and sell signals. In practice, the K line and D line are used in conjunction with the J line to form the KDJ indicator. Since the KDJ line is essentially a concept of random fluctuation, it is accurate for grasping the trend of medium and short-term market movements.

II. General Analysis of the KDJ Indicator

The stochastic indicator KDJ mainly analyzes overbought and oversold conditions, trend divergences, and phenomena such as the crossing of the K, D, and J lines to predict the medium, short-term, and long-term trends of stock prices.

KDJ is an analysis tool well-known to most investors in the market, but in specific applications, investors may find that the analysis results of KDJ differ significantly from actual trends, sometimes even leading to opposite conclusions.

The main reason is that most investors only know the general analysis principles and methods of KDJ and know very little about the connotations of the KDJ analysis indicator and specific analysis techniques.

We focus on the general analysis techniques and methods of KDJ popular in the market analysis, emphasizing the exploration of the intrinsic rules of the KDJ indicator and a detailed analysis of its special analysis functions.

The KDJ indicator consists of three lines, and its general analysis standards mainly consider seven aspects: the values of the three KDJ parameters, overbuying and overselling signals, the shape of the KDJ curve, the crossing of the KDJ curves, the divergence of the KDJ curves, the operating state of the KDJ curves, and the coordination of the KDJ curves with candlestick lines.

1. Range of Values for KDJ

In the KDJ indicator, the values of K and D range from 0 to 100, while the value of J can exceed 100 and fall below 0, but the analysis range of KDJ in analysis software is 0 to 100. Generally speaking, in terms of sensitivity, J is the strongest, followed by K, and D is the slowest; in terms of safety, J is the worst, followed by K, and D is the most stable.

2. Overbuying and Overselling Signals

Based on the values of KDJ, it can be divided into several areas: the overbought area, the oversold area, and the wandering area.

According to the general division standard, values of K, D, and J below 20 indicate the oversold area, which is a buy signal; values of K, D, and J above 80 indicate the overbought area, which is a sell signal; values of K, D, and J between 20 and 80 indicate the wandering area, where it is appropriate to wait and see.

Generally, when the values of K, D, and J are around 50, it indicates a balance of power between the bulls and bears; when all three values are above 50, it indicates that the bulls have the upper hand; when all three values are below 50, it indicates that the bears have the upper hand.

3. Shape of the KDJ Curve

The analysis of the KDJ indicator can also be done by looking at the shape of the KDJ curve. When the KDJ indicator curve forms head and shoulders, double tops and bottoms (i.e., M tops, W bottoms), and triple tops and bottoms, these can also be analyzed using the theory of shapes.

The various shapes that appear in the KDJ curve are a method of analyzing market trends and determining buying and selling opportunities. Additionally, trend lines, pressure lines, and support lines can also be drawn on the KDJ indicator curve.

When the KDJ curve is at a high position above 50, if the KDJ curve forms an M top or triple top reversal shape, it may indicate that the exchange rate will shift from strong to weak, and a significant drop is imminent, so it is advisable to close long positions and establish short positions promptly.

If the K line also forms the same shape, it can be further confirmed, and the magnitude of the drop can be judged using the theory of M tops or triple tops.

When the KDJ curve is at a low position below 50, if the KDJ curve forms a W bottom or triple bottom reversal shape, it may indicate that the exchange rate will shift from weak to strong, and a rebound is imminent, so it is advisable to establish a small number of long positions at low prices.

If the K line also forms the same shape, it can be further confirmed, and the magnitude of the rise can be judged using the theory of W bottoms or triple bottoms.

Among the shapes of the KDJ curve, the accuracy of M tops and triple tops is greater than that of W bottoms and triple bottoms.

4. Crossing of the KDJ Curve

The crossing of the KDJ curve is divided into two forms: the golden cross and the death cross. Generally, in a complete uptrend and downtrend process, the K, D, and J lines of the KDJ indicator will experience two or more “golden crosses” and “death crosses.”

When the market has been consolidating for a long time, and all three lines of K, D, and J are below the 50 line, once the J line and K line almost simultaneously break above the D line, it indicates that the exchange rate will turn strong, the consolidation and downtrend have ended, and an upward trend will begin, so it is advisable to start establishing long positions for medium and long-term holdings. This is one form of the KDJ indicator’s “golden cross.”

When the market has been consolidating after a period of rising, and the K, D, and J lines are hovering around the 50 line, once the J line and K line almost simultaneously break above the D line again, it indicates that the market is in a strong state, and the exchange rate will rise again, so it is advisable to increase long positions or hold long positions, which is another form of the KDJ indicator’s “golden cross.”

When the market has risen significantly after a long period of rising in the early stage, once the J line and K line almost simultaneously break below the D line at a high position (above 80), it indicates that the market will turn from strong to weak, and the exchange rate will fall, so it is advisable to close long positions and establish short positions, which is one form of the KDJ indicator’s “death cross.”

When the market has fallen for a period, and the exchange rate lacks the momentum to rebound upward, with various moving averages exerting strong pressure on the stock price, if the KDJ curve briefly rebounds to near the 80 line but fails to return above the 80 line, once the J line and K line break below the D line again, it indicates that the market will re-enter a bearish state, and the exchange rate will continue to fall, so it is advisable to close long positions and establish short positions, which is another form of the KDJ indicator’s “death cross.”

5. Divergence of the KDJ Curve

Divergence in the KDJ curve refers to when the trend direction of the KDJ indicator’s curve is opposite to that of the K line’s trend. There are two types of divergence in the KDJ indicator: top divergence and bottom divergence.

When the K line’s trend shows each peak higher than the last, indicating an upward trend in the exchange rate, and the KDJ curve’s trend on the KDJ indicator curve shows each peak lower than the last at a high position, this is known as top divergence. Top divergence generally signals a market reversal from a high position, indicating that the exchange rate will soon fall, and it is a signal to sell.

When the K line’s trend shows each trough lower than the last, indicating a downward trend in the exchange rate, and the KDJ curve’s trend on the KDJ indicator curve shows each trough higher than the last at a low position, this is known as bottom divergence. Bottom divergence generally signals a market reversal from a low position, indicating that the exchange rate will soon rise, and it is a signal to buy.

Like the divergence phenomena of other technical indicators, the accuracy of top divergence in KDJ is higher than that of bottom divergence. When the exchange rate is at a high position and top divergence occurs with KDJ above 80, the market will soon reverse downward, and investors should timely close long positions and open short positions.

Conversely, when the exchange rate is at a low position and bottom divergence occurs with KDJ below 50, it usually requires several occurrences of bottom divergence to confirm, and investors can only make strategic positions or short-term investments.

6. Operating State of the KDJ Curve

When the J curve begins to break above the K curve from the bottom (below 50), it suggests that the market’s weak consolidation pattern may be broken, and the exchange rate will move upward in the short term, allowing investors to consider building a small position.

When the J curve breaks above the K curve and moves rapidly upwards, also breaking above the D curve, it generally indicates that the market’s medium to long-term uptrend has begun, and investors can increase their positions.

When the K, D, and J curves start to break out of the narrow consolidation range of the earlier period and move upwards rapidly, it indicates that the market has entered a short-term uptrend, and investors should hold long positions in anticipation of further increases.

When the J curve turns downward after a rapid upward movement at a high position (above 80), it suggests that the exchange rate has risen too quickly in the short term and will begin a short-term adjustment, allowing investors to close long positions in the short term.

When the D curve also starts to turn downward at a high position, it suggests that the market’s short-term uptrend may have ended, and investors should close long positions and open short positions in the medium term.

When the K curve also starts to turn downward at a high position, it suggests that the market’s medium to short-term uptrend has ended, and investors should gradually open short positions to probe.

When the K, D, and J curves move downward from a high position simultaneously, it indicates that the market’s downtrend has formed, and investors should establish short positions.

7. Using the KDJ Curve in Conjunction with Candlestick Lines

When the KDJ curve and candlestick lines rise synchronously from a low position (KDJ values all below 50), it indicates that the market’s medium to long-term trend is positive, and the stock price is expected to continue rising in the short term, so investors should continue to hold positions or buy on pullbacks.

When the KDJ curve and candlestick lines fall synchronously from a high position (KDJ values all above 50), it indicates that the market will continue to fall in the short term, so investors should continue to hold short positions or sell on pullbacks.

When the KDJ curve falls from a high position, consolidates strongly for a period, then rises again and reaches new highs, and the Kline also consolidates strongly at a high position before rising again and reaching new highs, it indicates that the market’s upward momentum is still strong, and investors can continue to hold or increase their positions.

When the KDJ curve falls from a high position, consolidates for a period, then rises again, but turns downward near the previous high without reaching a new high, while the K line continues to rise slowly and reaches new highs, the KDJ curve and the stock price curve form opposite trends at a high position, which may mean that the market’s upward momentum is beginning to weaken, and top divergence appears in the KDJ indicator. At this time, investors should be very cautious, and once the candlestick line falls, they should decisively close long positions and open short positions.

When the KDJ curve, during a long-term downtrend, rebounds weakly for a period then falls again and reaches new lows, and the candlestick line also falls to new lows after weak consolidation, it indicates that the market’s downtrend is still strong, and investors can continue to hold short positions.

When the KDJ curve rebounds from a low position to a certain high, then falls again, but stabilizes near the previous low without reaching a new low, while the candlestick line continues to fall slowly and reaches new lows, the KDJ curve and the candlestick line form opposite trends at a low position, which may mean that the market’s downward momentum is beginning to weaken, and bottom divergence appears in the KDJ indicator. At this time, investors should also closely monitor market trends, and once it moves upward, they can make short-term buys, waiting for the rebound to occur.

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