Most trading strategies which trade trend and momentum reversals would trade reversal signals indiscriminately. An example of this would be the crossover signals wherein traders would trade in the direction of the reversal regardless of what the long-term trend direction is.
This trading strategy attempts to minimize the number of low probability and low potential yield trades by providing trade signals based on the confluence of the mid-term and long-term trends.
It also uses an indicator which is not as widely known by most traders, yet is also very effective in identifying trend and momentum reversals.
Step Stochastic Indicator
The Step Stochastic Indicator is a momentum based technical indicator which displays an oscillator line derived from the Stochastic Oscillator. Similar to the Stochastic Oscillator, the Step Stochastic Indicator also plots two lines which oscillates within the range of zero to 100. However, unlike the traditional Stochastic Oscillator, the Step Stochastic Indicator plots a line which does not oscillate smoothly. Instead, it plots a line which oscillates in increments causing it to plot lines which have a step like characteristic, thus it is called the “Step” Stochastic.
Most Step Stochastic Indicators use the Average True Range (ATR) to identify the minimum and maximum of a range, which is then applied to the Step Stochastics Indicator. However, this approach often causes the Step Stochastic lines to spike whenever there are huge market spikes.
This version of the Step Stochastic uses a “window” of price bars to minimize such fluctuations. This creates a more relevant indication of momentum direction based on the oscillations.
This indicator plots two lines which crossover each other depending on the direction of the momentum. These lines are called the step stochastic line and the step stochastic signal line. Momentum is bullish whenever the step stochastic line is above the signal line, and bearish whenever the step stochastic line is below the step stochastic signal line. This indicator also fills the area between the two lines to help traders easily identify momentum direction. It fills the area between the two lines sky blue to indicate a bullish momentum, and pale red violet to indicate a bearish momentum.
This indicator has five setting options which traders can use to modify its sensitivity.
“Price to use in calculations” refers to the price point on the price candle which the indicator would use for its calculations. This is preset as the Median price.
“ATR calculation period” refers to the number of bars the indicator uses for its underlying ATR computation.
“K slow” and “K fast” variables refer to the number of periods used by the indicator to compute for its underlying stochastics.
“ATR minimum maximum window size” refers to the number of bars the indicator would use for its ATR window.
200 Simple Moving Average
The 200 Simple Moving Average (SMA) is one of the most widely used moving averages. It is accepted as a prominent long-term trend indicator.
Traders would typically use it as a long-term trend indicator based on the location of price action in relation to the 200 SMA line. The 200 SMA line also typically sloped up whenever the long-term trend is bullish and down whenever the long-term trend is bearish.
Traders would also usually avoid trading against the long-term trend as indicated by the 200 SMA line as price has the tendency to bounce off it. This often causes trades taken against the 200 SMA line to have shorter price swings, while trades taken in the direction of the long-term trend often has the potential to produce higher profits.
The 200 SMA line is a built-in indicator on the MT5 platform using the “Moving Average” indicator. Users simply have to set the Period variable to 200 and the Method to Simple.
Trading Strategy Concept
The concept behind this trading strategy is to use the Step Stochastic Indicator lines crossover as a momentum reversal signal. However, instead of taking every reversal signal produced by the indicator, we will be trading only in confluence with the long-term trend as indicated by the 200 SMA line. This should allow for a better win ratio and higher potential yields which would result to better risk reward ratios.
Buy Trade Setup
Entry
- Price action should be above the 200 SMA line.
- The 200 SMA line should slope up.
- Price should retrace near the 200 SMA line.
- Open a buy order as soon as the Step Stochastic Line crosses above the Step Stochastic Signal Line and the filling between the two lines changes to sky blue.
Stop Loss Placement
- Set the stop loss on the support below the entry candle.
Exit
- Close the trade as soon as the Step Stochastic Line crosses below the Step Stochastic Signal Line and the filling between the two lines changes to pale red violet.
Sell Trade Setup
Entry
- Price action should be below the 200 SMA line.
- The 200 SMA line should slope down.
- Price should retrace near the 200 SMA line.
- Open a sell order as soon as the Step Stochastic Line crosses below the Step Stochastic Signal Line and the filling between the two lines changes to pale red violet.
Stop Loss Placement
- Set the stop loss on the resistance above the entry candle.
Exit
- Close the trade as soon as the Step Stochastic Line crosses above the Step Stochastic Signal Line and the filling between the two lines changes to sky blue.
Conclusion
The Step Stochastic Indicator is a decent mid- to long-term trend or momentum indicator. However, most Step Stochastic Indicators often loose its relevance whenever the market starts to have huge market spikes as this would often distort the range of the “step characteristic” of the two lines. This indicator has somehow addressed this weakness.
Since this indictor is best suited for the mid- to long-term trends, it is fitting that its signals are also filtered based on the long-term trend. This why the indicator tends to become more effective when paired with the 200 SMA line. It is not perfect, but it tends to produce trades with high win probabilities while also retaining the possibility of huge yields on its trades.
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Step Stochastic Crossover Trading Strategy for MT5