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.

Intersecting Lines of Interest

Any technical analysis tool is designed to identify the price level, with the greater probability of representing a future market turning point. Any trend line or indicator used on its own may only produce a 50% rate of accuracy.

However when multiple lines indicate a similar price level and trade theory, then our chances of being accurate may increase dramatically in our favor. For example, we can see based on the following (1-hour) chart, the GBPUSD recently broke down below a common trading range. During these consolidating ranges, traders may adopt a simple buy low, sell high approach. Most recently we can see resistance emerged in the form of a ‘double top’ pattern, which occurred very close to the longer term 50% Fibonacci retracement level. In addition, due to the fact that the overall trend appears to be to the downside, those trading with the trend, may choose to maintain at least a small position in the hopes of greater profits as this trading range turns once again into a trend.

The Stochastic Kiss Pattern

A unique way to utilize the stochastic indicator

Here is a simple technique I devised some years ago and introduced to the institutional market. It takes one of the markets' favored indicators Stochastics and identifies a pattern that when used in conjunction with other analysis can provide great trades.

It is called the "Stochastics Kiss" simply because of the appearance of the fast stochastic line dipping towards the slow line (in a move higher) or blipping higher towards the slow line (in a move lower) and then reversing the next bar.

It looks like this:

The image shows a section of slow stochastics, the blue line being %Fast D and the green line %Slow D. Note that during the strong rise in %SlowD on the left how the %FastD pulls back and then rises again the very next bar. It is effectively showing that price has corrected lower within the range but failed in the decline and caused a reversal back higher.

Equally, on the right we have the opposite. During the strong decline in %SlowD the %FastD pulls back higher and then drops again the very next bar.

These can often provide good trades that can be held for one or two bars at least and occasionally longer.

When looking at this pattern the very best examples are those where the %SlowD maintains the same direction as at Point 1. The %Fast D line moves up towards the %SlowD line and then reverses lower and a sale can be made on close. Note that after two bars profit is taken on close.

Point 2 is not a valid example with the rally higher and reversal in %FastD occurring while %SlowD has no direction. At Point 3 the same thing happens as at Point 2 so should not be used.

However, at Point 4 we see a valid pattern. It is not as clean as the first example since as %FastD dips and reverses higher %SlowD does the same but recovers to be higher again and more importantly higher than two bars prior. Again, a two day trade reaps profit.

What is important with this type of strategy is that price action is also scrutinized. It is important that the price extreme on the single bar move in %FastD does not penetrate a previous swing high or low. Remember the definition of an uptrend is that both highs and lows are moving higher and vice versa in a downtrend.

This most certainly occurs at Point 1 with the sharp correction in price remaining below the previous swing high. Equally, at Point 4 the corrective dip in price remained above the previous swing low and thus the underlying directional move remained intact.

Here is a second example of where this pattern has worked well:

This is the daily chart of the Pound versus the U.S. Dollar where we have seen two good sell signals and one buy signal, all making good profit.

I should add a few instances where it would be wiser to be cautious and possibly not take the trades. There are basically two things to look for:

• Where the Stochastic is either overbought or oversold. These could be considered but will require confirmation from price movement. However, quite frequently because of the extreme reading of the Stochastics there is a higher instance of the pattern breaking down.
• Where the reversal bar that completes the kiss pattern has seen a strong reversal that takes out the extreme of the last two bars then there is a risk of a delay to follow-through. Again any positions taken should be well guarded by a close stop loss.

You may also find that using the support and resistance levels from Pro Commentary, available through Dealbook may also provide guidance towhen to use this pattern.

Using Pivot Levels

Utilizing pivot areas along with your analysis can strengthen support and resistance

Not too many books will discuss the use of pivot levels, mostly the topic being covered as being calculated mathematically through the use of daily highs and lows. However, the is an alternative way of looking at pivot levels which, albeit subjective, can provide excellent trading opportunities.

Many years ago the concept of using prior support and resistance levels as pivotal areas became clearer to me after a discussion with a trader who had scant interest in technical analysis. I had just gone through the usual daily analysis and provided my report to the traders. For a moment I chatted within one trader who declared that he agreed with one of my resistance levels.

Now being dedicated to technical analysis I was rather intrigued how a trader who didn't pay any real attention to technicals could agree with a resistance level so I asked him how he arrived at that level also. His reply opened up an explanation to me on why these techniques often provide good trading opportunities.

His response was that when he was trading the same currency several weeks before he kept using this level as support and made profits on several occasions until price finally dipped below that support. He concluded that it would provide the same effect on the way up again.

Effectively, what he was describing was traders' memories, these being determined by the emotions of having made or lost money. Thus pivot levels represent emotions, the fundamental basis of technical analysis.

So how will these look?

It is quiet clear that in this 4-hour chart of the Euro against the US Dollar that price has been moving in each direction in steps, stalling in the general area of the previous major support or resistance. For example, the Euro rallied from the bottom left of the chart to bounce from the same level as the prior two troughs. Very simply this represents the basic theory that support remains as support until broken and once broken will provide resistance (and vice versa.)

Following the breach of the two prior lows price rallied and sees a correction. We cannot determine from this chart whether this was at a previous support level. However, the rally continues quite sharply and then corrects lower.

It then retraces back to a previous resistance level following which it reverses lower once again, breaking the previous corrective low and stalls in the area of the first price peak in the rally. In the subsequent rally it initially bounces from the first trough on the way down.

It will be useful to have these levels match with overbought/oversold levels in momentum studies and hopefully, in shorter time-frame charts, to displays bullish or bearish divergences at these pivot levels. If this occurs it provides a stronger signal for a bounce.

At times it is possible to use pivot levels and pivot lines. The latter occur when price oscillates around a line that is not horizontal but more like a trend line only there is no trend:

This is the daily chart of the British Pound against the Japanese Yen. Note how the price point ringed in black occurred when testing both a pivot support area and a pivot line support. These can be particularly effective in cross markets when used with charts constructed by a line on close.

Thus, do take note of these pivot levels as when companied with Fibonacci retracements or projections they can provide you with excellent trading opportunities.