Stochastic Mean Retracement Forex Trading Strategy

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Stochastic Mean Retracement Forex Trading Strategy

“Choose your battles wisely!” This is a popular saying used in different aspects in life. The same also applies in trading. Successful traders know when to trade and when not to trade. It is even a common occurrence in a day traders’ week wherein a trader would have a day without a single trade triggered. A wise trader would know if the market is prime for trading using the strategy that he is using.

If trading is a battle, then the market condition is the terrain of the battlefield. No general would want to wage war in a terrain wherein they are at a disadvantage. Commanders who know when and where to wage war are usually the ones who win. The same is true with traders. Traders should never take trades when the market condition does not favor their trading styles. Instead, traders should look for opportunities elsewhere or wait for the market condition to shift in their favor.

One of the best market conditions to trade in is a trending market. In these types of market traders tend to have a clear advantage because the market is moving strongly in one direction. Traders could easily identify which direction to trade in order to have a better probability of getting a winning trade.

Stochastic Mean Retracement Forex Trading Strategy is a trend following strategy that trades retracements towards the mathematical mean of a forex pair’s price. It uses a couple of technical indicators to systematically identify if the market is trending or not and identify specific retracement entry points within a certain trend.

Awesome Oscillator

The Awesome Oscillator (AO) is a trend following technical indicator used by traders to identify the general direction of the trend.

The AO measures momentum by computing for the difference between a 5 period Simple Moving Average (SMA) and a 34 period Simple Moving Average (SMA). However, instead of using the standard closing of price of each candle, the underlying SMA figures are derived from the midpoints of the high and low of each bar.

The figures are then plotted as histogram bars that oscillate as positive or negative. Positive bars indicate a bullish trend bias, while negative bars indicate a bearish trend bias.

The Awesome Oscillator could also be used to identify trend strength based on the color of the bars. Green positive bars indicate a strengthening bullish trend, while red positive bars indicate a weakening bullish trend. On the other hand, red negative bars indicate a strengthening bearish trend, while green negative bars indicate a weakening bearish trend.

Stochastic Cross Alert

Stochastic Cross Alert indicator is a trend following indicator based on the Stochastic Oscillator. It basically provides entry signals whenever the Stochastic Oscillator lines crossover.

The Stochastic Oscillator is a popular technical indicator that identifies momentum and trend direction based on historical price movements. It plots two lines that could move from 0 to 100. The range also has markers at level 30 and 70 to indicate possible overbought and oversold market conditions. Stochastic Oscillators typically indicate a possible momentum reversal whenever its two lines crossover.

The Stochastic Cross Alert indicator is based on this concept. It plots an arrow whenever it detects that its underlying Stochastic Oscillator lines have crossed over. These arrows could be used as entry signals or triggers to take trades.

Trading Strategy

This trading strategy is a trend following strategy that produces entry signals on retracements.

To trade this strategy, we first have to identify the direction of the trend. To do this, we will be using the 50 period Exponential Moving Average (EMA). The trend will be based on the slope of the 50 EMA line as well as the movement of price action. Price should be either making higher swing highs and swing lows to indicate a bullish trend, or lower swing highs and swing lows to indicate a bearish trend.

The Awesome Oscillator serves as a confirmation of the trend direction bias. The AO bars should agree with the direction of the trend based on whether the bars are predominantly positive or negative.

As soon as we confirm the trend, we could then look for possible trade entries based on retracements. To do this, we will be using the signals provided by the Stochastic Cross Alert indicator. Signals produced by the Stochastic Cross Alert indicator would verify that price has retraced deep enough to warrant a temporary short-term momentum reversal, and that the short-term trend has resumed the direction of the longer-term trend.

Indicators:

  • Stochastic_Cross_Alert_SigOverlayM_cw-signals
  • 50 EMA
  • Awesome

Preferred Time Frames: 15-minute, 30-minute and 1-hour charts

Currency Pairs: FX majors, minors and crosses

Trading Sessions: Tokyo, London and New York sessions

Buy Trade Setup

Entry

  • The 50 EMA line should be sloping up.
  • Price should generally be above the 50 EMA line.
  • Price action should be constantly making higher swing highs and swing lows.
  • The Awesome Oscillator should be positive.
  • The Stochastic Cross Alert indicator should plot an arrow pointing up.

Stop Loss

  • Set the stop loss at the swing low below the entry candle.

Exit

  • Close the trade as soon as the Stochastic Cross Alert indicator plots and arrow pointing down.

Stochastic Mean Retracement Forex Trading Strategy

Stochastic Mean Retracement Forex Trading Strategy 2

Sell Trade Setup

Entry

  • The 50 EMA line should be sloping down.
  • Price should generally be below the 50 EMA line.
  • Price action should be constantly making lower swing highs and swing lows.
  • The Awesome Oscillator should be negative.
  • The Stochastic Cross Alert indicator should plot an arrow pointing down.

Stop Loss

  • Set the stop loss at the swing high above the entry candle.

Exit

  • Close the trade as soon as the Stochastic Cross Alert indicator plots and arrow pointing up.

Stochastic Mean Retracement Forex Trading Strategy 3

Stochastic Mean Retracement Forex Trading Strategy 4

Conclusion

This trading strategy is a working trend following strategy which works well in a clearly defined trending market condition. It has a relatively high probability of producing winning trades. However, if used in the wrong market condition, the strategy may produce false signals due to choppy markets.

The key to trading this strategy correctly is finding trending markets that are clearly defined. If a market does not seem to be trending well enough, then it is best to look for opportunities elsewhere. Another option would be to scan through the timeframes of a currency pair to identify where the market is trending.

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