Trading Forex with Stochastics...Part 2

In the chart above, I have labeled for you three important stochastic trade indications. each one netted 200-400 pips. I know it is a little blurry, but this is a four hour chart of the eur/usd that includes today's trading activity. Also note, that if you pull up a chart of the eur/usd daily, you can see that it is plainly in a DOWNTREND. As we'll discuss today, the stochastice should be used to trade with the trend.

Last time we spent a good deal of effort to consider the stochastic oscillator. We talked about over bought and over sold territories, and how to use stochastics as a trading tool...when to enter a trade.

Let's refine this a little bit more. As the stochastic oscillator rises and falls, on first glance at any chart, it looks like an infallible indicator. But always remember, there is no such thing. Stochastics are most effectively used when combined with the trend. We talked about identifying trend early on at this blog so we won't repeat all that here. But if you search for it, the topic should be one of the very first ones. If you haven't read it, you should.

So when we combine the indicator with the trend, we find it will filter out a lot of bad trades. In other words, if the trend is up, you only want to be buying the currency pair anyway. Selling in an uptrend can be very costly. So only use the stochastic when it gives a buy signal in an uptrend. That is, it falls below the 20 line, and then turns upward, with the fast line crossing above the slow one.

In a downtrend you would do the same. This does not eliminate all bad trades, but it serves as a good filter.

Also remember that a stochastic can be used on any time frame chart, but the longer the time frame, the more reliable the signal (also the larger stop loss that must be used).

Finally, exiting a trade that you entered with a stochastic. If you really love this indicator, then you'll want an exit strategy after your trade has turned profitable. Once the pair has reached the far side of the indicator scale, is a good method. So if you bought during an uptrend when the s.o. fell below 20 and then turned up, you would sell when the indicator passed 80 on the top side. You may want to combine this with a trailing stop loss, which we'll talk more about tomorrow.

Until next time...Happy Trading!

Bill