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Stochastics Trading Strategy Part 2
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Stochastics: An Accurate Buy And Sell Indicator. Day Trading Strategy with the Stochastic Indicator. Building on the ideas expressed in the previous lessons, this lesson covers one particular strategy for day traders. The setup is a three-minute chart, which for this strategy is found to work better than the one minute or the five-minute. Also we are using the Stochastic Indicator rather than the Relative Strength Indicator as the oscillator, again because it seems to produce better results.
The idea of the strategy has been outlined previously. We are looking for a strong trend, which is usually accompanied by the oscillator going to and remaining at an extreme position. The first example shown is an uptrend, so the Stochastic Indicator is above 70%. This incidentally reinforces the idea that you should not trade simply because the oscillator reaches an extreme value. You would be waiting a while for the hoped-for reversal from overbought.
But when you do get a retracement, if it is significant enough you will find that the oscillator drops below the oversold level, 30% in this case. Given that the market is in a strong uptrend, this gives an opportunity for you to go long, anticipating the end of the retracement and a resumption of the trend upwards.
For the example given, only the %K line went below 30%, the signal line did not make it that far down before the trend resumed and the oscillator started going back up. If you had been trading on the signal line crossover, you would not have made this trade. But in the example it was taken as a strong enough signal because of the strength of the trend upwards in order to place a long trade.
There are a couple of additional points to make about this strategy. Firstly, it tends to work better in a downtrend, possibly because a downtrend tends to have bigger momentum. The price usually seems to struggle to go upwards, but can almost plummet when it is coming down with good reason. A stronger market sympathy makes for a more likely trade.
Secondly, it’s probably wise to limit this strategy to the first retracement in a strong trend. If you continue to look at the chart you will see that there are subsequent retracements and the Stochastic Indicator goes to an extreme, but the continuation of the trend is much weaker and may even fail, making trading on the trend continuing a more risky proposition.
So keeping it simple, look for a strong trend in one direction or another, watch for the retracement, and using the Stochastic Indicator take a trade with the original trend once the other extreme has been reached. This type of strategy works particularly well when day trading, and seems to work best on the three-minute chart.
As a reminder, not everyone is suited to day trading, as it is a fast and stressful way of trading. It is also a good way to lose money quickly if you’re not confident in what you are doing. But if this type of trading appeals to you, this strategy can be effective.
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