Stochastic Arrows Forex Trading Strategy

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Stochastic Arrows Forex Trading Strategy

“Trade with the trend”, we often hear this again and again. So, we try to learn how to identify a trend and trade accordingly. You see a chart that is rapidly rising, and you see a clear trend already formed so you buy into it. Then, as soon as you entered your buy order, the market whiplashes and sharply reverses. Then you hear another voice saying, “Don’t chase price!”

How do you trade with the trend but not risk buying at the peak or selling at the bottom? The answer, don’t chase price, let it come back to you. You do this by waiting for a retracement. A retracement is simply a temporary short-term reversal that goes against the trend. This is a commonly recurring theme in almost every trending market condition. Price seldomly goes on a straight line. It usually zigzags back and forth, up and down, even on a trending market condition. It seems as though after every run and every push towards the direction of the trend, price would take a breather before the next push. When you come to think of it, it is exactly that way. Traders who have entered the market on the right side would often cash-in on their profits from time to time causing price to either go sideways for a bit or even cause a retracement. Then, as price has gone back to a more reasonable price, traders with the same market sentiment would see value and jump back in causing price to resume its trend.

But how do we identify a retrace on a trend?

Stochastic Oscillators – Hint of a Retrace

On a ranging or choppy market, the stochastic oscillator often just bobs up and down crossing from overbought territory to oversold territory and back or anywhere in between. This would usually coincide with the swing highs and lows of that market. However, on a trending market, as the trend starts, the stochastic oscillator would usually be biased towards sticking to one side of the oscillator’s range and would seldomly touch the opposite overextended territory, whether overbought or oversold. But this condition wouldn’t last long. After makes the initial push on a trending market, it would often retrace back to the mean. This would then coincide with the stochastic oscillator going back to the opposite overextended area. On a bullish trend, the stochastic oscillator would touch the oversold area on the retrace. Flip it over on a bearish trend. After the retrace is where the magic happens. Price would often head back to its original trending direction, which we could jump on.

Trading Strategy Concept

This strategy is based on an indicator that pinpoints crossovers of the stochastic oscillator. As a standalone indicator, this indicator often gets the swing points right as the stochastic oscillator’s crossover points usually correspond to a short-term reversal.

To increase the odds of a successful trade, only signals generated by the indicator that agree with a fresh strong trend and is generated when the stochastic oscillator is on an overextended market condition will be taken.

To determine the trend, aside from visually seeing price move in a certain direction, we would also be using the commonly observed 50 Exponential Moving Average (EMA) as our basis for a trend. A bullish market condition would have price above the 50 EMA and have a 50 EMA that is sloping up. A bearish trend would be the opposite, with price below the 50 EMA and the 50 EMA sloping down.

Indicators:

  • Stochastic Oscillator
    • %K period: 5
    • %D period: 3
    • Slowing: 3
  • Stochastic_Cross_Alert
    • Default parameters
  • 50 EMA (green)

Timeframe: 1-hour and 4-hour chart

Currency Pair: any

Buy (Long) Trade Setup Rules

Entry

  • Price should be above the 50 EMA
  • The 50 EMA should be sloping up
  • Wait for the stochastic oscillator to go back to the oversold area below 20
  • Wait for a green Stochastic_Cross_Alert arrow pointing up to appear
  • Enter a buy market order on the confluence of the above rules

Stop Loss

  • Set the stop loss on the swing low below the entry candle

Take Profit

  • Set the take profit target at the most recent swing high

Stochastic Arrows Forex Trading Strategy 01 Stochastic Arrows Forex Trading Strategy 02

Sell (Short) Trade Setup Rules

Entry

  • Price should be below the 50 EMA
  • The 50 EMA should be sloping down
  • Wait for the stochastic oscillator to go back to the overbought area above 80
  • Wait for a red Stochastic_Cross_Alert arrow pointing down to appear
  • Enter a sell market order on the confluence of the above rules

Stop Loss

  • Set the stop loss on the swing high above the entry candle

Take Profit

  • Set the take profit target at the most recent swing low

Stochastic Arrows Forex Trading Strategy 03 Stochastic Arrows Forex Trading Strategy 04

Conclusion

This is a basic retrace strategy used by many professional traders. On the right market condition, trading instrument, and timeframe, this strategy would be a very high probability strategy.

This strategy doesn’t only work on the forex markets, but also on other trading instruments, whether commodities, stocks, or indices. However, if trading this on other instruments, take note of the time of day as this strategy could also be affected by it.

Lastly, avoid taking trades on a long overdue trend, which has higher chances of reversing. Some setups would result to an actual reversal of a trend, especially on the tail end of a trend.

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