Tag: Stochastic

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Forex Basic Strategies

The Best Tools to Trade Pullbacks Effectively

A Pullback is a pause, retracement, or consolidation of a price from the most recent peak during an ongoing trend. The pullback is widely seen as a trading opportunity after the underlying asset experienced a large upside or downside move. For example – Any forex pair is in a strong uptrend, and some healthy news came, and price action dropped back to the most recent support area that indicates the professional traders are booking the profits.

A Pullback is a pause, retracement, or consolidation of a price from the most recent peak during an ongoing trend. The pullback is widely seen as a trading opportunity after the underlying asset experienced a large upside or downside move. For example – Any forex pair is in a strong uptrend, and some healthy news came, and price action dropped back to the most recent support area that indicates the professional traders are booking the profits.

A Pullback is a pause, retracement, or consolidation of a price from the most recent peak during an ongoing trend. The pullback is widely seen as a trading opportunity after the underlying asset experienced a large upside or downside move. For example – Any forex pair is in a strong uptrend, and some healthy news came, and price action dropped back to the most recent support area that indicates the professional traders are booking the profits.

Pullbacks happen all the time, and if you learn how to trade them successfully, it can be a great skill as a trader. Trading the pullback is the easiest way to trade the market, sometimes you will recognize the high probability pullback trades and sometimes extreme volatile pullbacks, and you can enhance your repertoire and find many higher probability trades. If you are new in the market, then pullback trading is a fantastic and easy way to find superior risk-to-reward ratio trades. In this article, we will explore five trading strategies that provide excellent pullback trades.

Pullback Trading Strategies

Two-Legged Pullback To The MA 

Al Brooks popularized the concept of two legs pullback in his price action books. He explained most of the time, price action print two legs to reach the moving average. We backtested his strategy and found out that his techniques work very well in the trending market, but sometimes in the strong trending market, you will only witness one leg.

This is because most market operators are in a hurry to move the market; this may be because of any fundamental news. To filter out all the low probability trades, it is advisable to find a trending market and then wait for the price action to print the two legs towards the moving average, and when all the moves complete, take the buy entry.

The image below represents the buying trade in the EURGBP forex pair. The moving average indicates the buying trend in the currency. Price action pulled back to the moving average, prices responded from the moving average and goes a bit higher and end up printing the second leg. The second leg goes down to the moving average, but the strong buyers smack back up and close above the moving average. Furthermore, the price slows down a bit, and we took buying entry with the stops below the entry, and for taking profit, we choose the brand new higher high.

Candlestick Pattern + MA

This method will use the bullish engulfing candlestick pattern with a moving average to successfully trade the market.

Here we need two ingredients.

  1. Price action pullback to the moving average.
  2. The market forms a bullish engulfing pattern.

First of all, look for the strong trending market and wait for price action to approach the moving average. At this stage, if the price action prints the engulfing pattern,  it’s the right time for you to go for a buy entry. Otherwise, no entries are allowed for you. An  Engulfing Pattern indicates the sellers try to print the brand new lower low, but because of dynamic support of moving average prices pulled back and buyers end up eating all the sellers. As a result, we witnessed the Bullish Engulfing pattern.

The image below represents the buying trade in the EURNZD forex pair. As you can see, at the end of the downtrend, price action goes above the moving average, and we witnessed the engulfing pattern. The trading pattern closed above the moving average, which was a confirmation of buyers came back to the show and were expecting the brand new higher high.

Trendlines + Channel Trading

This one is the simple trading approach, which is not much popular, but it often generates wonderful trading results. First of all, you must draw the trend line to the ongoing trend, and when the price action pulls back enough, then draw the price channel to identify the oversold and overbought area. When price action approaches the trend line as well as the lower line of the price channel, it is an indication to go long.

The image below represents the buying entry in the AUDCHF forex pair. The trend line was the indication that the buyers are leading the show. During the pullback phase, when enough sellers approach the trend line and the lower channel line, it gave the strong buying candle. The reason we got the strong candle is because for the support and resistance trader, the zone was a dynamic support area to go long.

RSI + Stochastic Indicator

In this approach, we are using the two oscillators to trade the pullbacks. Stochastic and RSI both are oscillators, and they both oscillate between the significant levels. In an uptrend, wait for the price action to pull back. When the stochastic and RSI gave the oversold signal, it is a perfect time to go for a brand new higher high.

The image below indicates the buying trade in the AUDCHF forex pair. The pair was overall in an uptrend, and during the pullback, both of the indicators were showing the oversold signals, and the reversal at the oversold area was a great sign to go long. When both oscillators indicate the same sign, there is no point in going for more significant stops. When both oscillators gave the reversal signal at the significant resistance level, that’s a perfect time to close your trade.

Conclusion

All the pullback strategies share the same goal, which is to time the market. The better you master the skill of timing before the take-off, the more profits you will make. If you are a newbie trader, then master these strategies first on the demo and then apply to the live market because trying any of these strategies in the live market is dangerous without having any experience.

So never try anything on the live account. Instead, practice them on demo first and then make a profit on a live account. When you master these strategies, then you can very easily design a pullback strategy for yourself. Whichever strategy fits nicely into your trading approach, master it.

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Forex Basic Strategies

An Exclusive Strategy To Trade The Fiber (EUR/USD) Currency Pair

Introduction 

Introduction 

Introduction 

In the previous article, we discussed a trading strategy that was a combination of EMA and RSI. Presuming that all the readers easily understood it, we will now discuss a trading strategy that is a combination of three technical indicators. Today’s article will acquit us with another useful and reliable trading system that is based on the combination of Simple Moving Average, Stochastic Oscillator, and Relative Strength Index (RSI).

Time Frame

This strategy is only applicable on the 1-hour time frame. This is because all the indicators tend to sync in this time frame. Therefore, the strategy may not be suitable for day traders.

Indicators

The strategy consists of three indicators – a 150-period Simple Moving Average (SMA), Relative Strength Index (RSI) with period 3, and a Full Stochastic Oscillator with standard settings. The overbought and oversold levels for the indicators stand at 70-80 and 30-20, respectively.

Currency Pairs

As the name suggests, this strategy is exclusively meant for ‘EUR/USD.’ The liquidity and volatility of EUR/USD are extremely supportive of this strategy.

Strategy Concept

We first identify the direction of the market using the 150-period SMA and then establish a channel in the same direction. This is the first condition that has to be met before we can initiate a ‘trade.’ One could also this is a ‘channel’ based strategy as it involves going ‘long’ at the bottom of the channel and ‘short’ at the top once the indicators generate signals.

For a ‘long’ entry, we need to see if the Relative Strength Index drops in the oversold area. Once it drops, we look for a bullish crossover of the Stochastic lines, while they are also within their oversold zone. In simple words, we need a channel in a bull trend with both the indicators indicating that the market is oversold and with the Stochastic displaying a bull reversal.

Conversely, a ‘short’ trade is generated when the price starts moving in a downward channel in a bearish trend. The RSI and Stochastic should be in the overbought area that will later display a bearish reversal. As soon as the Stochastic fast and slow lines make a bearish crossover, we enter for a ‘sell’ on the next price bar. All of the above price action must happen below the 150-period SMA.

The strategy offers a high degree of capital protection as we place our stop-loss at the most recent ‘swing low’ or ‘swing high.’ As far as the ‘take-profit’ is concerned, we can use a fixed profit target, or we could scale out as the market approaches our target and protecting it with a trailing stop. An exit signal is also generated by the Stochastic indicator, which we will be discussing in the upcoming section of the article.

Trade Setup                     

In order to explain the strategy, we have considered the 1-hour chart of EUR/USD, where we will be applying the rules of the strategy to execute a ‘long’ trade.

Step 1: First of all, open the 1-hour chart of EUR/USD and establish the trend of the market. Plot Simple Moving Average (SMA) with a period of 150, Stochastic and Relative Strength Index with their default settings on the chart. If the price is above the 150-period SMA, we say that the market is in an uptrend. Whereas if the price is below the 150-period SMA, we say that it is in a downtrend. Next, draw a channel within the trend. It is better to have an upward channel in an uptrend and a downward channel in a downtrend.

Step 2: This is the crucial step of the strategy, where we align the three indicators together to generate a signal. After the identification of the trend and channel, we need to wait for the price to come at the extreme of the channel. In an upward channel, the price should be at the bottom of the channel, while in a downward channel, the price should be at the top.

Once the price reaches these extremes, we should watch the Stochastic and RSI. We enter ‘long’ when we notice a bullish crossover in Stochastic and an oversold circumstance of RSI (below 40). This means that the price might be putting up a ‘low’ that will result in a reversal. Similarly, we will go ‘short’ in the currency pair when we notice a bearish crossover in Stochastic along with an overbought condition of RSI (above 60).

The below image shows an example where the above step is being accomplished.

Step 3: In this step, we shall determine the Stop-Loss and Take-Profit for the trade where both these levels are derived mechanically. We place the stop-loss just below the ‘swing low’ from where the reversal took place. It will be above the recent ‘swing high’ in a ‘short’ trade. When speaking of the take-profit level, there is no fixed point for it. We take our profits when Stochastic reaches the opposite overbought/oversold level. At this point, we can either exit the trade, scale-out, or use a trailing stop. This can help in increasing the risk-to-reward (RR).

In our case, the risk-to-reward (RR) ratio of the trade was 1.5, which is above average.

Strategy Roundup

The RSI+Stochastic+SMA strategy is a reliable trend trading system that accurately pinpoints the bottom of a channel in a trend. More importantly, the strategy can provide the best-with-trend entry points that are necessary to increase the probability of winning. Since we are applying this strategy on a higher time frame, it will limit the effects of whipsaws that are encountered more often these days.

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Forex Basic Strategies

Pairing The ‘Gravestone Doji’ Pattern With Significant Resistance Levels

Introduction

Introduction

Introduction

Gravestone Doji is a bearish reversal candlestick pattern that occurs at the top of an uptrend. This pattern helps the traders to visually see where the significant resistance level is located on the price chart. The most important aspect of the Gravestone Doji pattern is its long upper shadow. The candlestick’s open, close, and low are all the same in this pattern.

The psychology behind the long upper shadow is this – In an ongoing uptrend, when the price action hits the significant resistance line, buyers exit their positions, and the price action is smacked down by the sellers. In short, the appearance of this pattern represents the losing momentum of the buyers and essentially indicates a bearish reversal in the market.

Most of the traders place their trades as soon as this pattern appears on the price chart. But that’s definitely not the right approach. Instead, we must wait for the next candle to close for the confirmation and only then take the trades. The opposite of the Gravestone Doji is the Dragonfly Doji, which appears at the bottom of a downtrend or the major support area. The below image represents the Gravestone Doji Pattern.

Trading Strategies – Gravestone Doji Pattern   

The Gravestone Doji pattern indicates that the buying trend is ending, and the market is reversing to the selling side. However, this doesn’t hold true all the time. We will be finding this pattern quite often in all the types of market conditions, and if we start trading every time we find them, we will end up on the losing side. We always need to ask our self the reason why this pattern appears in certain conditions. Is it going to reverse the market or not?

Pairing the pattern with a significant resistance level

If you find this pattern at the bottom of the range, do not trade it. But if the price action prints this pattern at the top of a range, it can be considered a sign for us to go short. Similarly, find the trending markets and look for a major resistance level where the price could possibly react. So when the price action prints a Gravestone Doji at the major resistance level, it’s a strong sign for us to go short.

In the below USD/CHF Forex chart, we can see that the price action has printed the Gravestone Doji pattern at the significant resistance level. We should be going short as soon as the Doji candle closes.

In the below image, we can see that we took a sell entry when the market printed the Gravestone Doji pattern. We have placed the stop-loss just above the resistance level. It is safer to put the stop-loss above the pattern or at the resistance line because if the price goes above the pattern, the pattern gets invalidated. We know that the Gravestone pattern indicates a market reversal, and most of the time, these reversals travel quite far. That is the reason why we go for deeper Take Profits.

In the above chart, we can see that we had exited our full positions when strong buyers showed up. This indicates that the sellers are losing their momentum, and there is no logic to continue holding our positions.

Gravestone Doji + Stochastic Oscillator

The strategy that we shared above is for aggressive traders who like to take risks. However, if you are A type of trader who needs more confirmation to pull the trigger, we suggest you follow this strategy to trade this pattern. Most of the conservative traders do have a fear in their minds that one single candle does not have the potential to reverse the market. And it is completely okay to think like that. The truth is that sometimes even a single candle can move the market, and sometimes it doesn’t. Ultimately it is your money management system that makes all the difference.

But to filter out some poor signals and to get an additional confirmation, it is advisable to use the Stochastic oscillator to confirm the probability of our trading signal. Stochastic is a range-bound indicator that oscillates between the 0 & 100 levels. When the Stochastic goes above the 70 level, it means that the market is in an overbought condition, and we can expect a change in the trend. Likewise, when it goes below the 30 levels, it means that the market is oversold are we can expect a reversal anytime soon.

The Stochastic indicator also shows the bearish and bullish divergence, which helps the traders in trading the upcoming reversals. The divergence is when the market moves in one direction, but the indicator is signaling a different direction. Now we believe that you understand the basics of trading with the Stochastic indicator. Now let’s dive into the strategy.

The strategy here we are using is simple and straight forward. First of all, identify the Gravestone Doji pattern at a significant resistance level in an uptrend. Then, apply the Stochastic indicator to the price chart and check if the indicator is at the overbought area, indicating a downside reversal. If yes, go short and place the Stop-Loss just above the pattern.

The GBP/CAD chart below indicates the appearance of the Gravestone Doji pattern in an uptrend. When the price is approaching the upper resistance level, it got smacked down immediately, and the market ended up printing the pattern. The next six candles tried very hard to break the pattern & resistance line, but nothing worked, and the price ended up rolling down. We can also observe the Stochastic indicator was at the overbought area, which is a confirmation sign for us to go short.

We have entered for a sell when both the conditions are met, and placed the Stop-Loss just above the pattern. For the Take-Profit, we choose to go for deeper targets. When the selling trend started to struggle, the Stochastic indicator was at the oversold selling conditions. At that point, we have closed our full positions for obvious reasons.

Conclusion

The trades taken based on the Gravestone Doji pattern are pretty reliable. But do not make the mistake of identifying the pattern everywhere on the price chart. The psychology behind this pattern says that the bulls drove the price to a peak point, and the sellers are comfortable in reversing the market. For booking profits, you can expect an equal move to that of a previous trend. If you are an intraday trader, make sure to exit your positions at any significant level. Although this pattern appears on all the timeframes, the reliability is higher on higher timeframes to that of lower timeframes.

We hope you find this article informative. Try trading this pattern on a demo account and master it before applying the above-mentioned strategies on the live market. Cheers.

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Forex Course

86. Learning To Trade Using The Dependable ‘Stochastic Oscillator’

Introduction

Introduction

Introduction

Stochastic is a momentum indicator that was developed in the late 1950s by ‘George Lane.’ This indicator does not follow the volume or price of the underlying instrument; instead, it measures the speed and momentum of the price action. As a result, the indicator changes its direction before the price itself. This makes the Stochastic a leading indicator in the market.
We can change the sensitivity of this indicator to the market movement by adjusting the settings. Stochastic is a bounded indicator which oscillates between the 0 to 100 level. When the indicator reaches the 70-level, it indicates the overbought markets, and when it goes below the 30-level, we can assume that the market is in an oversold condition. The bullish and bearish divergences on the Stochastic indicator help us in anticipating the upcoming price reversals.

Trading Strategies Using The Stochastic Oscillator

Oversold & Oversold Areas

This is the basic yet powerful Stochastic strategy that is widely used by most of the traders. The idea is to go long when the indicator reverses at the oversold area and go short when it reverses at the overbought area. Let’s understand this with an example.

The image below is an NZD/CAD Forex price chart. It represents two buying and one selling opportunity in an uptrend. These trades are solely taken based on the strategy that we discussed above.

We have placed the stop-loss just below the recent candle and close our position when the market gave an opposite signal. The market circumstances don’t matter as this indicator can be used in any situation. The crucial thing is to follow the rules of the indicator very well.

If the indicator generates a buy signal, only take buy entries, and when it says sell, only consider selling opportunities. If we are in a buy trade and if the indicator represents a sell trade, that is the time to close our position. Never be rigid and ignore the indicator signals to hold the position for extended targets. If that happens, we will be on the losing side.

Stochastic Indicator + Bollinger Bands

Bollinger band is a leading indicator, and it consists of two bands, which are above and below the price action. This indicator also has the centerline, which is a Moving Average. The bands of the indicator expand and contracts according to market volatility. They expand if the volatility is more and contract when the volatility is less.

Buy Example

First of all, find an uptrend in any Forex pair. When the price action hits the lower Bollinger Band, see if the Stochastic indicates the oversold market condition. If it does, it means that the sellers now have a hard time to go lower and taking buy entries from here will be a good idea.

As you can see in the below image, the EUR/AUD was in an uptrend. During the pullback phase, the Stochastic reaches the oversold area, and the price action hits the lower Bollinger Band. This is an indication to go long in this pair. As we have activated our trade, the price action blasts to the north. We can close our position when the Stochastic indicator reaches the overbought area. If you want to ride longer moves in the trending market, exit your position at the major resistance area.

Sell Example

First of all, find a downtrend in any Forex pair. When the price action hits the upper Bollinger Band, see if the Stochastic is indicating overbought market conditions. If it does, it means that the buyers now have a hard time to go higher and taking sell entries from here will be a good idea.

The image below is the EUR/CHF Forex pair, and the pair was in an overall downtrend. During the pullback phase, the price action turned sideways. But when the price action hits the upper Bollinger Band and the Stochastic indicator reverses at the overbought area, it is a sign to go short in this pair.

We can place the stop-loss just above the upper Bollinger band, and the take-profit must be at the higher timeframe’s support area. If you are an intraday trader, close your positions when both the indicators give an opposite signal.

That’s about Stochastic indicator and related trading strategies. If you have any doubts, let us know in the comments below. Cheers.

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Forex Course

78. Brief Introduction To Technical Indicators & Indicator Trading

Introduction

Introduction

Introduction

In the past two sections of this course, we have discussed two of the most important tools in Technical Analysis – Fibonacci & Moving Averages. These two are discussed in an elaborated way because you might be using them in conjunction with many of the other reliable indicators in the market. They can be used standalone not just to take trades but also for different other purposes. For instance, Moving Averages can be used to identify the direction of the trend. Likewise, Fibonacci Levels can be used to test the reliability of any support and resistance level.

Since we have completed learning these crucial tools, it’s time for us to extend our learning to understand specific technical tools known as indicators and oscillators. There are many indicators and oscillators in the market. Some are reliable, and some are not. So in the next few course lessons, we will be discussing some of the most credible and reliable indicators. In this lesson, let’s first understand what an Indicator basically is and why it is important to use them in technical analysis.

What is an Indicator?

An indicator is a tool that is used by technical traders and investors to understand the price charts and market conditions. The important purpose of any indicator is to interpret the existing data and accurately forecast the market direction. These indicators are built on various mathematical calculations by market experts.

These days, with the advent of technology, hundreds of indicators can easily be accessed. They are available on most of the charting platforms that we currently use, like MT4 & TradingView. Many of the reliable indicators we have today are a result of extensive research and back-testing. Any technical indicator considers a lot of important data like historical price and volume to predict the future price of an asset.

Indicators are an integral part of technical analysis, and the number of traders who just rely on indicators to take trades is pretty high. Typically, most of the indicators overlay on the price charts to predict the market trend. However, there are indicators that position themselves below the price chart to make users understand the overbought and oversold market conditions.

Oscillators are nothing but range-bound indicators. Which means, an oscillator can range from 0 to100 levels (0 being the floor and 100 being the roof). Essentially, if the price of an asset is at 0, it represents oversold conditions. Likewise, if the asset’s price is at 100, it represents overbought conditions.

Two Types of Indicators

Indicators are classified into two different types – Leading Indicators & Lagging Indicators. As the names pretty much suggest, leading indicators are those that predict the future price direction of any given currency pair. Essentially, these indicators precede the price action and predict the price.

Leading Indicator Examples: RSI (Relative Strength Index), Stochastic Indicator, & Williams %R.

Contrarily, lagging indicators act more like a confirmation tool. They follow the price action and help traders to understand the complex price charts better. One of the best use cases of a lagging indicator could be while testing the trend. We can confirm the trend along with its strength using a lagging indicator.

Lagging Indicator Examples: MACD (Moving Average Convergence & Divergence) & Bollinger Bands.

That’s about a brief introduction to Indicators and Indicator trading. In the next lesson, let’s understand the pros and cons involved in Indicator trading. Once that is done, we can start learning some of the most reliable indicators and how to trade the markets using them. Cheers.

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Forex Basic Strategies

Making Consistent Profits with ’10 Pips A Day’ Forex Strategy

Introduction

Introduction

Introduction

There is a lot of buzz in the Forex industry about the ten-pip a day strategy. We have seen both experienced and novice traders getting excited about this strategy. So we decided to talk in detail about this topic in today’s article. Some expert traders believe that it’s not possible to make ten-pip consistently in the market, while many others say it is possible.

In reality, it entirely depends on the person’s trading skills, mindset, and experience. Traders need to adapt themselves to the market situations to be successful. Making ten-pip a day is a great way to accumulate wealth in the Forex market, and it is easily possible. All we need is to master our skills to the point where we exactly know when to take a trade and when not to.

Statistics say that it’s not easy to make consistent money in the Forex market, and the losses are a part of the game. This is true to an extent, but if we practice this strategy enough on a simulator, we can easily make ten pips a day no matter what. In this article, let’s understand how to make ten pips per day in the Forex market by using five different buy and sell examples of five trading days in a week.

Trading Strategy For Making 10 Pips A Day

’10 Pips A Day’ – The idea behind this term is to stop trading for the day right after making ten pips that day. Also, it is up to you to follow this idea or not. You can stop trading after making ten pips, or you can ignore that and go for 20, 30, or even 100 pips a day according to the market situation.

But only go ahead if you are 100% confident about the markets. In case of any tiny bit of uncertainty, make sure to exit right after you make ten pips. One critical aspect of this strategy is selecting the currency pairs. One must be professional enough to understand the market situations and pick the pairs where there is a minimum potential of making ten pip profits.

Pairing The Bollinger Bands With The Stochastic Indicator

Rules For Going Long
  1. The market must be in a strong uptrend.
  2. Wait for the price action to slowdown at the lower Bollinger Band.
  3. Let the Stochastic Indicator reverse at the oversold area.
  4. Only go long if the above two rules are satisfied. Also, consider the momentum of the price.
  5. Place the stop-loss just below the lower Bollinger Bands.

Now, to understand how this works, we have taken five different trades for five trading days in the last week of Feb 2020 and have generated 10, 20, and 30 pips in the market successfully. According to this strategy, conservative traders must stop trading after making ten pips for that trading day. But, if you are an aggressive trader, go ahead for bigger targets. Let’s get into the examples.

Monday Trade

The below chart represents a buy trade in EUR/CAD Forex pair. When all the rules mentioned above are met, we took a long position in the New York Session on 24th Feb 2020. Our stop-loss is placed right below the lower Bollinger Band.

We have gone for three different targets according to the market situations and predominant S&R levels. As mentioned, exit the trade as soon as you make ten pips if you are a conservative trader.

Tuesday Trade

For the second day, we have picked the EUR/AUD Forex pair as we identified some potential market moves. We have gone long on this pair in the New York session on 25TH Feb 2020. We can clearly see both the indicators indicating a clear buy signal.

Here, we have gone for the third target and exited the trade as soon as we made 30 pips.

Wednesday Trade

Our third trade was in the EUR/CAD Forex currency pair in the Asian session on 26th Feb 2020. When prices hit the lower Bollinger bands, and the Stochastic indicated the oversold market conditions, we went long on this currency pair.

We would have exited the trade at ten pips, but the market started printing continuous bullish candles, which made us wait for the prices to hit the third target.

Thursday Trade

On the 4th day (27th Feb 2020), we took a long position in the AUD/NZD Forex pair. The entry was at the point where the prices touched the lower Bollinger Band, and the stop-loss is placed just below the recent low.

Since the higher highs were getting continuously printed, we went for the third target and exited the trade as soon as we made 30 pips.

Friday Trade

For the Friday trade, we chose the AUD/NZD Forex pair. We went long in the Asian session on 28th Feb 2020. When both the indicators lined up in one direction, it is a clear indication that the sellers have given up, and now it’s time for buyers to lead the market.

We had exited at the third target even when the market was moving up north.

 Rules For Going Short
  1. The market must be in a strong downtrend.
  2. Wait for the price action to slowdown at the upper Bollinger Band.
  3. Let the Stochastic Indicator reverse at the overbought area.
  4. Only go short if the above two rules are satisfied. Also, consider the momentum of the price.
  5. Place the stop-loss just above the upper Bollinger Band.

Monday Trade

The below chart represents the first sell trade we took in the NZD/JPY Forex pair on the 24th Feb 2020. We went short when the price action hit the upper Bollinger band, and the Stochastic indicated the overbought conditions.

The stop-loss is placed just above the upper Bollinger Band. We have gone for the third target, and the market printed a brand new lower low.

Tuesday Trade

The below image represents the USD/CHF Forex pair. This pair was in an overall downtrend, and on 25th Feb 2020, we have activated the sell trade right after our sell criteria is met.

We can see the market reaching all of our targets in just a couple of hours.

Wednesday Trade

For the third day, we have chosen the USD/CHF Forex pair to identify the sell opportunities on 26th Feb 2020. The entry was at the point where the price action touched the upper Bollinger band, and the stop-loss was just above the upper band.

The reason we place the stop-loss there is because of the bands of the indicator act as a dynamic support resistance level to the price action.

Thursday Trade

The 4th trade belongs to the CAD/JPY Forex pair, and we have activated our sell trades on 27th Feb 2020. We took sell when both of the indicators lined up in one direction, and we booked profit at the third target.

Friday Trade

For the last sell trade, we chose CAD/JPY currency pair. Sell trade was activated on Friday, 28th Feb, in the Asian session. When the Stochastic reached the overbought area and gave a sharp reversal, we saw the price action hitting the upper Bollinger band. This essentially means that the market is ready to go down.

Bottom Line

In almost all of the cases, we have gone for the third target only and make 30 pips profits. The reason behind this is to show you how reliable is the Bollinger Band and Stochastic combination. We are saying this time, and again, please stop trading after making ten pips per day if you are a conservative novice trader. But if you are experienced enough to predict the market, milk as much as you can depending on the market conditions. All the best.

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Forex Basic Strategies

Trading The Most Profitable Candlestick Pattern With Stochastic Indicator

Introduction

Introduction

Introduction

Throughout the years, many professional traders and chartists spent thousands of hours in front of their screens and have invented hundreds of candlestick patterns that show in the market. Some of these patterns work very well, and some failed miserably. A lot of traders believe that pattern trading doesn’t work. But it is just a myth. Pattern trading does work if we use it in conjunction with other credible trading tools.

Most of the novice traders make the mistake of treating A candlestick pattern as a trading signal. They need to understand that the patterns alone do not hold enough power to reverse the trend of the market. Most of the candlestick patterns are defined by using the last three to four candlesticks alone. Also, most importantly, they ignore the price action context.

This is the reason why we always urge our readers to combines candlestick patterns with other trading tools like credible indicators or oscillators. In this article, we will be sharing one of the most profitable trading strategies that we have ever come across. It involves a candlestick pattern and a technical indicator.

Engulfing Pattern + Stochastic Indicator

After extensive research and backtesting, we found that the Engulfing Pattern is the most profitable Pattern when confirmed and traded with the Stochastic Indicator. Before going right into the strategy, let’s talk about the Stochastic Indicator and Engulfing Pattern in the interest of novice traders who have never heard of these things before.

Stochastic Indicator

George Lane developed the Stochastic Indicator in the Late 1950s. It is one of the most prominent indicators in the industry, and it has been identifying credible signals consistently in all the types of markets from the past 60+ years. The Stochastic is an oscillator, and it changes its direction even before the price action. It measures the relationship between the underlying asset’s closing price and its price range over a specific period of time. Just like other indicators, stochastic doesn’t follow the volume and price. Instead, it follows the momentum and speed of the price to identify the overbought and oversold areas.

Engulfing Pattern

Engulfing is one of the most prominent candlestick patterns in the market. This Pattern frequently appears in the Forex market than the stock or futures market. There are two types of Engulfing Patterns in the market – Bullish Engulfing Pattern & Bearish Engulfing Pattern. Engulfing is either a bullish or bearish reversal pattern, and it prints at the end of any prevailing trend.

Bullish and Bearish Engulfing Patterns

The Bullish Engulfing Pattern always appears in a downtrend. It is a three candle pattern. The first candle is Red; the color of the second candle doesn’t matter. Most of the time, the second candle is a Doji candle. The third candle is super important as it must be Green in color for the pattern confirmation. Also, it must close above the first Red candle.

Conversely, the Bearish Engulfing Pattern appears in an uptrend, and it indicates the bearish reversal. The first candle is Green in color, and that suggests the uptrend is still ongoing. The second candle is Doji, and the color doesn’t matter much. The third one is the decision making candle, which must be Red in color. This indicates the buyers not having enough power to lead the market.

Trading Strategy

Buy Example

This strategy works very well in all the timeframes. So irrespective of you being an intraday trader, swing trader, or an investor, you can still use this strategy. If you are a 60-minute trader, only trade with the current timeframe trend. Adding additional timeframes to this strategy often creates confusion, and as a result, it leads to wrong decision making. The strategy is as follows:

  • The very first step is to find a downtrend in any underlying security.
  • With a bullish view, look for a Bullish Engulfing Pattern.
  • Then apply the Stochastic Indicator on to the charts
  • To take a trade, the Stochastic must be in the oversold area. If the Stochastic is at the overbought area and you see a Bullish Engulfing Pattern, do not take the trade.

In the below GBP/CAD Forex chart the bottom panel shows the Stochastic Indicator. We can see the market was in an overall downtrend. At the end of the downtrend, we can notice the market printing the Bullish Engulfing Pattern. We can also see the crossover of the stochastic indicator at the same time.

This shows that the sellers are exhausted and buyers gaining control in this pair. If at all you are trade the Engulfing patterns alone, make sure to wait for two to three confirmation candles after the Pattern to enter the trade. Here, in our case, there is no need to wait for the next two-three candles as Stochastic confirms the Bullish Engulfing Pattern’s signal. Also, if we would have placed the Take Profit accurately, the winning pips in this trade would be huge. Hence we call this the most profitable candlestick pattern.

Sell Example

  • Firstly, check if the market is in an uptrend.
  • With a bearish view, look for the Bearish Engulfing Pattern.
  • The third step is that the Stochastic must be in the overbought area.
  • If the Stochastic is at the oversold area and market prints a Bearish Engulfing pattern do not take the trade.

In the below USD/CHF Forex pair, the overall market was in an uptrend. When the market turned sideways, it has printed the Bearish Engulfing Pattern. We can also see the Stochastic Indicator in the overbought area. Hence this is a clear indication of Sell trade in this pair. After the signal, price action turned sideways for a longer period. Here, a lot of amateur traders exit their positions if the price takes too long to respond.

But we suggest you have faith and only exit your trades when it hits the stop loss. In our case, we can see the price action holding for sometimes, and when it rolls over, it gave stronger moves. In the below image, we can see that after holding sideways, price action dropped very hard, and we booked full positions at the major support area.

Bottom line

Engulfing Pattern is quite popular, and one of the most profitable patterns that exist in the industry. It often provides good risk-reward ratio trades. When we master the combination of Engulfing Patterns and the Stochastic Indicator, we can easily take our trading to a whole next level. Combining these two technical tools is a sound approach, as they quickly help us in filtering low probability trades. This strategy works well in both ranging market conditions and trending/dying market conditions.

We hope you find this information useful. Test this strategy in a demo account before applying it to the live markets. Cheers!

Categories
Forex Basic Strategies

Pairing The Shooting Star With Stochastic & Awesome Oscillators

Introduction

Introduction

Introduction

The Shooting Star is one of the most popular bearish candlestick patterns in the industry. This pattern appears in an uptrend most of the time, and it indicates bearish reversals in the price action of any underlying currency. So basically, when this pattern appears on the charts, it implies that the buyers are exhausted, and its sellers turn to lead the market. Once we have identified the Shooting Star pattern in an uptrend and confirm the trend reversal with any other credible indicator, we should look to open a short position.

This pattern has a unique structure as it consists of a small body and a high upper wick, as shown in the image below. This image accurately represents the trend reversal because we can clearly see the buyers losing momentum and sellers taking over the market.

Trading strategies with the Shooting Star pattern

Shooting Star + Stochastic Indicator

In this strategy, we have paired the Shooting Star pattern with the Stochastic Indicator to identify the trading opportunities. Just like RSI and MACD, the Stochastic Indicator also belongs to the oscillator group. It is developed in the 1950s, and it is still widely used by the traders. The Stochastic indicator oscillates between 0 & 100 levels. When the indicator goes below 20, it means that the currency pair is oversold. Similarly, when the indicator goes above the 100 level, it indicates that the currency pair is overbought.

STEP 1 – First of all, find the Shooting Star pattern in an uptrend.

STEP 2 – Check the Stochastic indicator

Once you find the Shooting Star pattern, the next step is to check the Stochastic Indicator. If the indicator is giving a reversal at the oversold area, it indicates the overbought market conditions.

The image below represents the EUR/USD weekly Forex chart. In this pair, price action was held at a significant resistance area, and it prints the Shooting Star pattern. Also, the Stochastic indicates the overbought conditions. These three clues clearly say that this pair is all set to change its direction. The Stochastic pattern on a higher timeframe has very higher chances to perform. So whenever you find this pattern, and if it supports the rules of this strategy, always trade big.

Step 3 – Stop-loss and Take Profit

A stop loss is specially designed to limit the loss of the trader. So before activating your trade, it is essential to decide where you are going to place the stop loss. In the example above, we put the stop loss just above the Shooting Star candle.

Shooting Star pattern indicates the reversal in price action. This means that we are catching the top of the trend. As the end goal of every trader is to maximize their profits and minimize losses, always try to hold the positions for more extended targets.

In the example, we have closed our position at a higher timeframe support area. We can use the higher timeframe support or look for the Stochastic Indicator to reach the oversold area. Another way to close the position is when the market reaches the major support area while the Stochastic is in the oversold area.

As we can see in the image below, we closed our full position at a significant support area. You can use the Stochastic or any other trading tool to exit your position, but we always suggest to use the considerable support/resistance area to book profits.

Shooting Star Pattern + Awesome Oscillator

In this strategy, we have paired the Shooting Star pattern with the Awesome Oscillator to identify the trading opportunities. The Awesome Oscillator is a boundless indicator. When the Awesome Oscillator reverses below the zero-level, it indicates the buying pressure. When it reverses above the zero-level, it means sellers are ready to lead the market. Furthermore, some traders use this indicator to confirm the strength of the trend. When the indicator goes above zero-level, it means the buying trend is quite strong, and when it goes below the zero-level, it shows the sellers dominating the market.

Step 1 – First of all, find the Shooting Star pattern in an uptrend.

Step 2 – Look for the Awesome oscillator reversal

Once we find the Shooting Star pattern, the next step is to take a sell-entry when the Awesome Oscillator reverses at overbought market conditions.

The image below is the EURUSD 240 chart. On this pair, at first, the buyers were quite weak, and they started holding at the resistance area. Furthermore, in that small range, price action turned sideways, and it printed the Shooting Star pattern. The Awesome Oscillator even reversed at the overbought conditions. Both of the trading tools are indicating the exhaustion of the buyers. And sellers are ready to take over the market.

Step 3 – Take Profit and Stop loss

Every trader has different expectations from the market, some like to trade short term trends, and some like to trade longer-term moves. If you are an intraday trader, then we suggest you close your position when the Awesome Oscillator reverses at the oversold area. But, if you are a swing trader or investor, wait for the opposite pattern (Hammer Pattern) to appear to close all of your positions. We can even use the higher timeframe support/resistance area to close our positions.

We advise you to place the stop-loss order above the Shooting Star pattern. As you can see in the image below, we booked full profits at the major support area. After that, the price action dropped a bit more but reversed immediately to follow the buy direction. It is important not to ignore the higher timeframe support/resistance areas.

The psychology behind the Shooting Star Pattern

At first, we see the buyers enjoying the uptrend as the price of the currency keeps printing brand new higher high. As this euphoric moment begins to set in, the sellers start to sell their positions at higher prices. Now the buyers get panicked, and even they start to sell their positions. Now that the buyers and sellers are both selling their positions, panic is created in the market, which leads to a sharp reversal in price action. Thus a long wicked small body candle appears on the trading charts.

Keep in mind that the Shooting Star pattern is more reliable when it is formed after the three consecutive bullish candles. It creates strong bullish pressure on the price chart, and in such cases, the upper wick of Shooting Star is even longer. It indicates that the price is about to reverse with even more strength.

Bottom line

The Shooting Star is a single candle pattern, and it is the most popular trend reversal pattern in the industry. There is a strong psychological pattern that exists beyond the Shooting Star pattern. When the market is in an uptrend, and when buyers gain exponential strength, most of the traders book the profit, and as a result, the bullish trend loses its strength. This results in sellers sending the price down. Most of the time, the Shooting Star pattern provides the 3:1 risk-reward ratio trades.

We hope you find this article informative. Please let us know if you have any questions regarding the same in the comments below. Cheers!

Categories
Forex Basic Strategies

The Most Simple Scalping Strategy To Trade The Forex Market!

What is Scalping?
Scalping is one of the trading styles in the forex market, which is gaining popularity with the emergence of artificial intelligence and automated trading systems. Nowadays, there

What is Scalping?
Scalping is one of the trading styles in the forex market, which is gaining popularity with the emergence of artificial intelligence and automated trading systems. Nowadays, there

What is Scalping?

Scalping is one of the trading styles in the forex market, which is gaining popularity with the emergence of artificial intelligence and automated trading systems. Nowadays, there are a set of traders who enjoy scalping than day trading, swing trading, or position trading.

The main difference between scalping and other styles of trading is that in scalping, the trading time frame is very short and face-paced. The holding period does not last more than a few minutes, whereas ‘positional’ traders hold their trades from 1-Hour to few weeks. Scalpers find trading opportunities on very short timeframes such as the 1-Minute and 3-Minutes.

Impulsive traders are the ones who are most attracted to scalping, as they don’t want to wait for a trade to set up on the higher time frame. Sadly, new traders fall into this trap and start scalping the market, totally unaware of the risk it carries.

To scalp, a trader needs to be experienced. We recommend first being consistently profitable on the higher time frame or swing trading and then move on to scalping. Because this form of trading is extremely difficult as it requires a trader to make decisions in mere seconds or minutes.

5-Minute Scalping Strategy

In this section, we’ll cover a simple yet very effective scalping strategy on the 5-minute timeframe. The most suitable time to implement this strategy is during volatile market conditions. This means the best results are obtained during the New York-London session overlap (8:00 AM to 12:00 PM EST). During this time, trading costs are also relatively low, and liquidity is high, which is essential for the scalpers to take a trade.

We will be using two exponential moving averages in this strategy. Below are the indicators that one needs to apply to their charts.

  • 50-Period exponential moving average
  • 200-Period exponential moving average
  • Stochastic indicator

The Strategy

Let us look at the detailed steps involved in the 5-minute scalping strategy.

Step 1️⃣ – Identify the current trend

The two EMAs are used to indicate the trend in the 5-minute chart. To identify the larger trend, a trader will have to change the time frame to 15-minutes. Identifying the bigger trend is crucial to understand the overall direction of the market. The 50-period EMA is much faster than the 200-period EMA, which means it reacts to price changes more quickly.

If a faster (50-period) EMA crosses above the slower EMA (200-period), it means the prices are starting to rise, and the uptrend is more likely to be established. Similarly, a cross of faster EMA below the slower EMA indicates a drop in the price, and that also means a downtrend is about to form. Always make sure to take trades in the direction of the major trend.

Step 2️⃣ – Look for a pullback

Once we determine the current trend on the 5-minute chart based on EMA’s, it is time to wait for a pullback and stabilization of the price. This is one of the most important steps in this strategy as prices tend to make false moves after strong ups or downs. By waiting for the pullbacks, we can prevent ourselves from entering long or short positions too early.

Step 3️⃣ – Confirmation with the Stochastic Indicator

Finally, the Stochastic indicator gives the confirmation signal and helps us to take only highly-profitable trades. A reading above 80 indicates that the recent up move was strong, and a down move can be expected at any time. This is referred to as the overbought market condition. Whereas, a reading below 20 indicates that the recent down move was strong, and an up move is about to come. This market condition is referred to as the oversold market condition. After a pullback to the EMA’s, the Stochastic Indicator’s final confirmation gives us the perfect trade entry.

Let us understand this strategy better with the help of an example.

Chart-1

The above figure is a 5-minute chart of a currency pair, and the 200-period EMA is represented by the orange line while the 50-period EMA is represented by the pink line. The cross of the pink line above the orange line signals that the currency pair is entering into an uptrend on the 5-minute chart. As long as the faster EMA remains above the slower EMA, we’ll only look for buying opportunities. This step is to identify the direction and crossing of the two EMAs.

Chart-2

A trader shouldn’t be going ‘long’ as soon as they see the lines crossing. They should always wait for the pullback and only then take an entry. In ‘chart-2’, when we move further, we were getting the kind of pullback that we exactly need.

The next question is, at which point to buy?

Chart-3

The Stochastic plotted in the above chart helps in giving us the perfect entry points by getting into the oversold area. One can take a risk-free entry after all the indicators support the direction of the market.

Chart-4
Finally, the trade would look something like this (chart-4). The risk to reward ratio (RRR) of this trade is 2:5, which is very good. Also, make sure to place precise stop-loss and take profit orders, as shown above.

Final words

Scalping is a faced-paced way of trading that is preferred by a lot of traders these days. The main difference between scalping and other styles of trading is the timeframes involved in analyzing the market. This type of trading carries certain risks that are unavoidable, such as high trading costs and market noise, which can impact your profits. We hope you find this article informative. Let us know if you have any questions below. Cheers!

Categories
Forex Basic Strategies Forex Trading Strategies

What Should Know About Trading Ranges Using Support & Resistance?

What is Range trading?
It is said that the market only trends for 30% of the time. So it becomes necessary to have a range trading strategy to take advantage

What is Range trading?
It is said that the market only trends for 30% of the time. So it becomes necessary to have a range trading strategy to take advantage

What is Range trading?

It is said that the market only trends for 30% of the time. So it becomes necessary to have a range trading strategy to take advantage of the other 70% of the time. Range trading is not difficult, but it requires discipline and determination to make most out of it. When a market is trending, it forms a pattern of higher highs and higher lows, in case of an uptrend. The move, in this case, is really strong and is known as an impulsive move. The other type of movement is known as the corrective move, which comes in the form of a pullback. Impulsive moves are stronger than corrective moves.

When the market is making any such moves, it finds itself stuck between a high or low and continues to oscillate between these two points. It means buyers and sellers are equally strong, and this creates a very choppy environment.

Traders now trade these extremes and continue to trade until price breaks out on either of the sides. These two points act as potential support and resistance points, used by traders to place their orders.

In the above chart, we have drawn a few lines from where the market bounced off. The price action in those areas creates many trading opportunities. The instrument in the chart first trends down and then puts up a low (marked by line 1). Initially, you might think it as a downtrend and expect the pattern of lower lows and lower highs to continue.

Then you see the market rally to line 2, from where the market falls back to line 3 but does not fall till line 1. This highlights the fact that the market is no more trending. The market instead could be stuck in a range between line 1 and line 2. These are not ‘defined’ prices. Always consider them as zones with a margin of error both outside and inside the range. A trader will look to position himself/herself at these zones of support and resistance that forms the range.

Why support and resistance?

The price that is stuck between these two extremes has a lot of significance. This is because, at this point, the price can either Stop, Reverse, or Breakout. When you have the right knowledge, it will stop you from simply pushing the buttons and will make you trade with a defined strategy.

Range = Consolidation

A range is nothing but a price consolidation of the overall trend move. It could either end the current trend or cause a reversal. The different price behavior pattern in the range creates many trading opportunities, which can be traded by all types of traders, depending on their risk appetite. Now let’s discuss some important trading strategies using support and resistance of ranges.

Strategy Using Technical Indicators

Using technical indicators to trade can aid your trading strategy. Especially while trading ranges, many indicators can be a part of your trading plan. Here, we have used the Stochastic Indicator as a tool to trade the ranges.

In the above image, the two lines represent the support and resistance of the range formed. When the price reaches the resistance at point 1, the Stochastic enters the overbought area, and the slowdown in momentum is the confirmation signal for a sell. The resistance pushes the price back to support (point 2), but this time the momentum is very strong, hence no entry. The stochastic also does not enter the oversold area clearly. Next time the price goes to resistance with greater momentum, and the Stochastic too does not give an entry signal as it is not in the overbought area. This means one shouldn’t be going short at this point.

Overall, there is only one risk-free trade available in the above chart, and that is at point 1 (short).

Strategy Recap

Firstly, we should be able to see the price at one of the extremes. When that happens, the indicator should show either be at overbought or oversold conditions. The momentum of the price should be an important factor that determines our entry. If we see reversal patterns, this could be the best entry with a good risk to reward ratio. Do not forget to place protective stops much below or above the support and resistance levels, respectively. This will always protect your trades from a false breakout.

When not to buy at support and sell at resistance in ranges

You must have probably heard traders saying that more time a level is tested, the stronger it becomes. This is not true in the case of our range break-out strategy. You need to start paying attention to the price patterns at these ends. If the price has made multiple touches, it could be getting ready for a breakout in the direction of the higher time frame.

The above chart is an example of such a scenario. It shows a range, and at point 1, you can see the strength in the candle as price pushes towards the resistance area. The next push makes the price to consolidate at the extreme. It appears to be a battle between the bulls and bears. It is also making higher lows as a part of the uptrend. Hence a breakout after this point is not surprising.

You don’t want to see the higher lows at the resistance extreme and lower highs at the support extreme.

The resistance could still work, and a reversal could happen, but this type of price action does not give much confidence for shorts. Only aggressive traders may find some entry in that consolidation, for a potential long. They can put a protective stop below the higher low that was formed before the accumulation.

We hope you find this strategy informative. Let us know if you have any questions in the comments below. Cheers!

Categories
Forex Educational Library

Profitable Trading VIII – Computerized Studies V: Oscillators

Introduction

Markets behave as a fair-price searching machine. When there is no consensus about value, caused by an economic event or some other news that might affect the current fair price, market forces launch a new trend, which starts moving the price toward another “fair” level.

And the rest of the time, when the price is already at a consensus “fair price”, what happens? Does it stay at a single price point until a new event shakes it?

Nature hates stillness and rest. It seeks movement -Any kind of movement- and the markets do, as well. Therefore, as we all acknowledge, price does not stay still just because everybody on earth thinks this is the fair price. The fact that there are zillions of market participants, every one of them with its own opinions, makes it impossible that a fair price exists at all. As Jesse Livermore stated, the two most significant market forces are greed and fear, and, consequently, they exert their pressure on prices, too.

Therefore, when a market lacks impulse to continue a trend, it tends to make oscillatory price changes, although the fact that traders are using different time frames, price targets, and stops, makes this oscillation quite complex, with multiple cycles blended on an intricate and, potentially, noisy pattern.

Science has been dealing with waves and cycles for long. Almost everything in science deals with cycles and oscillations, therefore, cycles are a part of markets that may be handled with precise scientific accuracy, limited only by the noisy nature of prices.

To conclude, Markets mainly behave in two interlinked modes: trend mode and cyclic mode. Those two states may blend with each other on a higher timeframe, though.

We’ve already dealt with computerized studies to help traders find and trade a trend. In this article, we’re going to analyze several computerized studies which might assist us during the cyclic phase of the market, when the markets are not trending.

Slow Stochastics

The Stochastics oscillator was developed by George Lane, who teach it during his investment seminars since 1950. According to Lucas and LeBeau on his book “Computer Analysis of the Futures Markets”, Mr. Lane has been perfecting the use of stochastics for trading over many years, and he is able to make it work well in almost any market situation.

The Stochastics Oscillator, came from the observation that closing prices tend to appear near the high of the range during uptrends and near the low of the range in downtrends.

This oscillator measures where the close is, relative to the range of prices over the latest period. The %K line comes from a simple formula, which makes sure the signal is always between zero and 100:

There is a %D line, which is called slow stochastic and is computed by applying a three-day moving average to the %K line.

By convention, an overbought market is one that led its stochastics lines – %K and %D – above the +80 level; while a market is in oversold condition when they are below the 20 level.

The basic way to use Stochastics is by acting at %D and %K crossovers when this happens at those extremes, and when the %D line crosses – over or under- these price triggers. For example, when %D crosses under the 80 level it indicates a sell signal, and when it crosses over the 20 level, it’s a buy signal.

Periods

The standard period for the Stochastic oscillator is 14, but, according to Lucas and LeBeau, George Lane used an adjusted value of about 50% of the perceived market main cycle. Those authors said in their book that they had tested several periods, and a range between 9 and 12 were the best performing ones, as these were the best compromise between speed and validity, producing the minimum quantity of false signals.

What this tells us is that we need to experiment with the period of the signal and back-test it, to get an optimal figure for the current market we are treading.

According to Alexander Elder, if you intend to use Stochastics as your sole signal it’s better to choose a longer-term period, while in combination with other signals a shorter period is preferable.

Signals against the trend

As said at the beginning, the use of this kind of oscillator is best suited to a cyclic phase of the market. When we detect a trend, the Stochastic oscillator does not perform so well, especially when the signal is against the main trend.

Fig. 2 shows a stochastics used in a downtrending market (NZD/YSD). We may observe that, mostly, good signals come from the overbought side of the market that trigger signals with the trend, even when those appear before %K and %D approaches the saturated region. This is common with strong trends. The market doesn’t reach the overbought ( or oversold) level before returning to the primary trend. The only potentially profitable buy signal comes at the end of this long downtrend when the oversold condition permeates several time frames.

LeBeau and Lucas said in his book: “Remember: The trader who coined the phrase ‘the trend is your friend’ was not using stochastics”.

Divergences

Several authors agree about the fact that divergence between prices and stochastics is one of the most powerful signals.

A bullish divergence occurs when a price makes a new low and the stochastic fails to do so, drawing a higher low.

A bearish divergence arises then prices are making new highs but stochastics lines draw a lower low.

A word of caution about divergences: It may work or not. I don’t know for sure. What’s sure is its performance is very challenging to test. I’d rather like those signals that I’m able to back-test, such crossovers, departures from an overbought or oversold level,  etc.

Knees and Shoulders

When %K has crossed over %D and, then, pulls back, but, without another %D crossing to the downside, and, next, it resumes its up movement, Mr. Lane calls it a knee. If the movement is from overbought to the downside, he calls it a shoulder. According to Mr. Lane, it shows a continuation with strength.

Anticipating a crossover

There are people that remark when %D flattens, call it a hinge. Also, there’s a warning hook, when both %K and %D turns at an extreme but still don’t cross.

According to LeBeau and Lucas, those observations focus, mainly, on anticipation rather than reliance on the signals, and they don’t recommend them. It’s better to wait for a crossover.

Bear and bull setups

Another unique tool by George Lane.

A bear setup happens when prices make a series of higher highs and higher bottoms, but the Stochastics oscillator produces a pattern of lower lows when prices are rising. This pattern indicates there will be a top soon.

Bull setups are the specular pattern to bear setups, indicating that a bottom will happen soon.

Williams %R

Williams Percent R is a momentum indicator developed by Larry Williams, very similar to the Stochastic indicator, but in this case, it computes the level of the closing price in relation to the highest high of the period, instead of the lowest low, and it doesn’t depict a smoothed %D line.

 

Therefore, this oscillator moves from -100 to 0. Values below -80 are oversold levels while from -20 to 0 are overbought levels.

Some charting packages shift these values to positive 0 to 100 by adding 100 to the formula. In this case, oversold levels are between 0 and 20, and overbought condition happens from 80 to 100.

%R is noisier than Stochastic %D, but with less lag, so together with a confirming pattern,  it usually allows for a better reward to risk ratio and tends to show more trade opportunities than Stochastic does.

 

This indicator is very good at detecting oversold conditions at an uptrend, or overbought levels at a downtrend, therefore, it’s well suited as a signal, to add to a position or enter a new one on pullbacks.

Advanced topics:

Adaptive Stochastics Indicator

John Ehlers introduced the idea of an adaptive indicator in his book “Cycle Analytics for traders.” Ehlers proposes to, first, find the dominant cycle first, and then use half of that cycle as the period for the stochastic calculation.

So, the adaptive Stochastics starts by computing the dominant cycle using an autocorrelation periodogram, which Ehlers describes in chapter 8 of his book (I will refer the interested readers to check it).

In his book, Ehlers showed the complete algorithm, as well (although written in easy-language, it may be transposed to any language). The main steps are:

  • A low pass roofing filter to eliminate unwanted noise from the price data
  • The periodogram calculation
  • The instantaneous period is used to compute the current value of %D.
  • No %K is computed.

As we observe from fig. 8, the adaptive stochastic is much less noisy and it adapts to the dominant cycle.

Center Of Gravity

John Ehlers describes this oscillator in chapter 5 of his book “Cybernetic analysis for stocks and futures, cutting edge DSP technology to improve your trading”. He states that this study is unique because his smoothing has virtually zero lag, therefore, enabling a definite identification of turning points at the same time.

The center of gravity of an object is, basically, a weighted center of its mass, a balance point. In a trading environment, we can define a kind of rule of weights on an observation window. A fast and upward moving price shifts the center of prices to the right, while a downward move, shift it to the left.

The following formula computes CG:

CG = ∑i=0 to N (xi +1) * Pricei / ∑ i = 0 to N   Pricei

Fig 9 shows the EUR/USD 10-minute chart with Center of Gravity. As we clearly see, the CG is almost free of noise, so a signal can be picked directly from its crossovers if they happen relatively far from its zero line.

Cyan and pink boxes on Fig.9 show the result of scalping on a 10-min EUR/USD chart using CG crossovers. Nothing is perfect in trading, but we clearly observe that CG crossover signals catch the turning points with accuracy, allowing a highly probabilistic approach to scalping.

Stochastizing indicators

Stochastizing indicators is another development by John Ehlers, which he introduced in his book Cybernetic analysis for stocks and futures.

We may “stochastize” any indicator by computing its value in comparison with its lowest value of a period. Below, is an example of Stochastics RSI, much easier to use than in its original form.

The example in Fig. 9 shows entries and exits following the trend, discarding those against it, depicting high accuracy and early signals that allow for good reward-to-risk ratios. If we take the complete bull and bear signals, the stochastic RSI signal is still quite reliable. Just the trades against the trend do not present such good profits, but do not show significant losses either.

 Inverse Fisher Transform Percent R

The idea of a transform is to map some domain into another domain. The Inverse Fisher transform maps an indicator, %R in this case, into another kind of domain that allows us to alter its probability density function (PDF).

Market prices don’t fit on a Gaussian PDF, the familiar bell-shaped normal distribution, instead, prices have fat tails, meaning that large bull and bear events are more probable than a normal distribution allows. The Fisher transform can be applied to prices, such that it makes the resulting distribution nearly Gaussian.

The following equation defines the Fisher transform:

y = 0.5 x ln [ (1+x)/(1-x)]

This function compresses prices, to cut the fat tails, making the resulting price distribution Gaussian.

The inverse Fisher transform, instead of being compressive, is expansive.  Its equation is:

x = (e2y – 1) / (e2y +1)

The shape of the transfer function of an inverse Fisher transform is a kind of sigmoid function. The resulting output has a higher probability of it being +1 or -1. This -almost saturated- function makes the inverse fisher transform behave like the output function of an artificial neuron. The resulting shape shows trend changes very early.

To conclude, we have seen that the use of advanced signal processing is a way to improve classic indicators, for them to show less lag or behave in ways not achieved by conventional means.

To do so, we are required to do a bit of programming, to translate the algorithm into our trading platform. It may be useful to do an internet search because there are lots of free translations of popular indicators to major trading platforms.

This article section was just, the starting point for those with interest in advanced indicators.

A very good article, including MT5 code, is https://www.mql5.com/en/articles/288, where you may get actual code to implement the ideas sketched here.

 

References:

Computer Analysis of the Futures Markets, LeBeau and Lucas

Cycle Analytics for Traders and Cybernetic analysis for stocks and futures, cutting edge DSP technology to improve your trading,  by John Ehlers.

Charts created using MT4 and Multicharts trading platforms.

 

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