Stochastic Forex Trading System
This topic should be called: Combining Stochastics with other Indicators, but Stochastic Forex Trading System sounds real nice.
Stochastic Oscillator can be combined with other indicators to form a forex trading system. For our example we will combine it with:
- Moving Averages
From our trading system the sell signal is generated when:
- Both Moving Averages are moving down
- RSI is below 50
- Stochastic heading downwards
- MACD moving downwards below center-line
The sell signal was generated when all these trading rules were met. The exit signal is generated when a signal in the opposite direction is generated i.e. when the technical indicators reverse.
The good thing about using such a trading system is that we are using different types of indicators to confirm trade signals and avoid as many whipsaws as possible in the process.
- Stochastic - is a momentum oscillator
- RSI- is a momentum oscillator
- Moving Averages- is a trend following indicator
- MACD- is a trend following indicator
It is very useful to combine more than one indicator, as a combination of trading signals is better than relying on just a single indicator. The indicator combinations reinforce each other, and cancel out false whipsaw signals.
A trend following indicator helps a trader to see the overall picture, while using more than one momentum indicator gives better and more reliable entry & exit points for trading.
The indicators combinations and their signals help to decipher a lot of the market activity.
For this example the trend is clearly upwards, but at some point there were a few whipsaws generated by the stochastic oscillator, can you spot them? So the question is how can a trader avoid trading these whipsaws?
Well, the answer is that by looking at the other indicators such as MACD a trader could have avoided the whipsaw, even the MACD had not given a crossover signal although it was very close to the zero center-line level, at the same time the gradient at which the moving averages turned was not so sharp as to warrant a decisive trend reversal. Well the thing is that it’s not so obvious when it comes to recognizing whipsaws; it is a skill that takes some time but after some time you can spot whipsaws from a mile away.
One tip is that as long as MACD is above zero center-line even if the MACD lines are heading downwards then the trend is still upwards. As you can see from the above example MACD never went below zero line and afterwards the upward trend continued with the MACD maintaining above Zero line and continuing to move upwards.
During ranging markets Stochastic Oscillator will give the fastest signals which are prone to whipsaws. This is why stochastic is best combined with other indicators and signals traded are confirmed by other one or two other Forex indicators.