Stochastics Cross Signal

A useful strategy to reduce your losses using stochastics crossover signals

Stochastics are often used to generate buy and sell signals when the %FastD crosses above or below %SlowD. Just how good are these signals?

The stochastic plot here shows where entries are indicated:

I have not circled all the signals but just four in the center of the chart that only shows the stochastic plot. The buy signal occurs when %FastD crosses above %SlowD and the sell signal occurs when the opposite is seen - when the %FastD crosses below %SlowD. However there are two other signals in between that provide first a sell signal and then a buy the next bar. This is rather annoying.

Let us seen how the entries might look on a chart.

Clearly, when there is a modestly sustained move the Stochastic crossovers can provide a reasonable profit but all too often in the small, rather tight range consolidations it can give back much too much of hard earned profits.

Is there any way we can try and prevent this give back? I tend to consider the plain signals provided by momentum indicators as too simple and in a way that doesn't really fully take price development into consideration. Does a reversal of the %FastD through %SlowD constitute a directional reversal? Personally I do not think so.

Then what does represent directional reversals? Well, if you go back to a fundamental premise on what constitutes a trend it can be defined by looking for higher highs and higher lows in an uptrend and vice versa for a downtrend. If we then just trade without looking at the price chart just because %FastD has crossed through %SlowD then we're really not think about what we're doing. Quite often price can see a one or two bar reversal but not to the extent that it penetrates the most recent sequence of higher lows (in an uptrend) or lower highs (in a downtrend.)

What we can do is stipulate that we'll only buy on a Stochastic cross higher if price penetrates the last swing high, or if the Stochastic crossover is lower then on the breach if price penetrates the last swing low:

You can see by doing this it does reduce the number of trades dramatically but actually takes out most of the losing trades. The first short sell to the bottom left of the chart will produce a loss - but this is compared to 6 losing trades without the price filter. The long trend is kept intact in the center of the chart as price rallies and is reversed soon after the peak. We then see two sell signals with no buy signals.

The techniques is not foolproof, as any methodology has its weak points at times, but it can be seen that using a price signal along with a momentum signals can dramatically reduce the number of losses you may need to take on using such a strategy.

Using Multiple Time Frames in Your Analysis II

Utilizing a lower time frame chart to identify when Bollinger support/resistance will hold

Following on from the first description of using multiple time frame charts to both strengthen your analysis and enable tighter entry and exit trades, let us take another look at using these in a different example.

Many traders like to use Bollinger Bands to try and identify entry signals. The problem I have always had with them is that they only provide approximate support and resistance which causes problems in knowing where you should enter and where the stops should be placed. Not only that but sometimes they just don't seem to work at all as a support/resistance tool and the judgment of when they'll work appears purely subjective.

Take a look at the daily chart of GBPUSD:

In the center of the chart we can see that price has declined to the Bollinger low and on first touch it does bounce only to fall below the lower band and does so on three consecutive days. On the day before the absolute low Rapid RSI moves into the oversold extreme. Does this mean we can buy? Maybe. Sometimes it works and sometimes it doesn't.

So what should we do?

The following chart is the 2 hour chart showing the approach to the low at 1.9400.

On the left of the chart we can see that price falls below two identical lows and these can then be considered as pivot resistance. We then see the three pushes lower and on the daily chart we know that the Rapid RSI went into an oversold extreme.

Do we buy at that point because is looks like the Rapid RSI on the 2 hour chart is developing a bullish divergence? The answer is "no." Divergences should only be traded on a break of a pattern. In this case we have an intermediate downtrend line and it is only after the final low that price breaks above the trend line and thus confirms the bullish divergence in Rapid RSI. You will also note that following the break above the trend resistance that price reverses briefly to retest the trend line which provides a second buying opportunity.

Following the break of the trend line which was the day after the daily oversold reading price rallies by 200 points. That's a good profit… Not only that, by waiting and observing the 2-hour chart you can avoid trying to pick the bottom as suggested in the daily chart.

Remember, it is normally best not to try and pick tops and bottoms as these will often provide losing trades. Waiting patiently for the right signal by fine-tuning the entry on a shorter time frame chart can reduce losing trades and make the final trade a more profitable one.

Using Multiple Time Frames in Your Analysis

A technique to improve your trading decisions

Have you ever seen RSI overbought and wonder whether it was the right time to sell? Let's face it, an overbought reading in a momentum oscillator can merely mean that price is strong and may even turn into an uptrend.

Is it a valid overbought signal? Do you sell? Where do you sell? Where should you place your stop?

Quite often using two charts of different time frames can help. For instance, let us suggest you have seen an overbought reading in the daily chart but there is no bearish divergence. What you can do is look at a shorter time frame chart, a 4-hour or 2-hour chart to see what is happening there an whether a more accurate sell signal can be identified.

Let us look at recent example in EURUSD:

Above is the daily chart of EURUSD as it approached 1.3258. Daily Rapid RSI was showing an overbought reading but there was no bearish divergence. From this chart alone we probably couldn't work out whether there was a selling opportunity or not.

This second image is the 2-hour chart of EURUSD but here it can be seen that the peak at 1.3258 was accompanied by a bearish divergence in Rapid RSI. We are therefore on warning that a reversal can occur and that the daily overbought reading may well be correct.

Next we have to identify a selling level and in this case it is on the break of the price support line which has touched price four times before it finally breaks and this is where we can place our sell-stop. The money management stop should ideally be placed above the 1.3258 high but if this is too high and would cause a large loss then we can look at placing a stop above the rising trend line. However, do note that is a rising trend line and could mean that your stop needs to be raised to allow a possible retest of the line.

In this case the trade would have been very profitable with a decline down close to the daily pivot support which rests around 1.3050. A take profit order can be placed just above this to exit the position at a tidy profit.

Using Multiple Time Frames in Your Analysis

A technique to improve your trading decisions

Have you ever seen RSI overbought and wonder whether it was the right time to sell? Let's face it, an overbought reading in a momentum oscillator can merely mean that price is strong and may even turn into an uptrend.

Is it a valid overbought signal? Do you sell? Where do you sell? Where should you place your stop?

Quite often using two charts of different time frames can help. For instance, let us suggest you have seen an overbought reading in the daily chart but there is no bearish divergence. What you can do is look at a shorter time frame chart, a 4-hour or 2-hour chart to see what is happening there an whether a more accurate sell signal can be identified.

Let us look at recent example in EURUSD:

Above is the daily chart of EURUSD as it approached 1.3258. Daily Rapid RSI was showing an overbought reading but there was no bearish divergence. From this chart alone we probably couldn't work out whether there was a selling opportunity or not.

This second image is the 2-hour chart of EURUSD but here it can be seen that the peak at 1.3258 was accompanied by a bearish divergence in Rapid RSI. We are therefore on warning that a reversal can occur and that the daily overbought reading may well be correct.

Next we have to identify a selling level and in this case it is on the break of the price support line which has touched price four times before it finally breaks and this is where we can place our sell-stop. The money management stop should ideally be placed above the 1.3258 high but if this is too high and would cause a large loss then we can look at placing a stop above the rising trend line. However, do note that is a rising trend line and could mean that your stop needs to be raised to allow a possible retest of the line.

In this case the trade would have been very profitable with a decline down close to the daily pivot support which rests around 1.3050. A take profit order can be placed just above this to exit the position at a tidy profit.