Technical Indicators Forex Trading with Stochastics

Stochastics are amongst the most popular technical indicators when it comes to Forex Trading. Unfortunately most traders use them incorrectly. In this article we will review the correct way to use this popular technical indicator.


George Lane developed this indicator in the late 1950s. Stochastics measure the current close relative to the range (high/low) over a set of periods.


Stochastics consist of two lines:


%K - Is the main line and is usually displayed as a solid line
%D - Is simply a moving average of the %K and is usually displayed as a dotted line


There are three types of Stochastics: Full, fast and slow stochastics. Slow stochastics are simply a smother version of the fast stochastics, and full stochastics are even a smother version of the slow stochastics.


Interpretation:

Buy when %K falls below the oversold level (below 20) and rises back above the same level.

Sell when %K rises above de overbought level (above 80) and falls back below the same level.

The interpretation above is how most traders and investors use them; however, it only works when the market is trendless or ranging. When the market is trending, a reading above the overbought territory isn't necessary a bearish signal, while a reading below de oversold territory isn't necessary bullish signal.

Trending market

When the market is trending is necessary to adapt the oscillator to the same conditions: When the market is trending up, then the signals with the higher probability of success are those in direction of the trend "Buy signals", on the other hand when the market is trending down, selling signals offer the lowest risk opportunities.


Thus when the market is trending up, we will only look for oversold conditions (when the stochastics fall below the oversold level [below 20] and rises back above the same level) to get ready to trade, and in the same way, when the market is trending down we will only look for overbought conditions (when the stochastics rise above de overbought level [above 80] and falls back below the same level.

Taking all overbought/oversold signals during a trending market will lead us to many whipsaws. If you are not comfortable with the number of signals given, try expanding your trading to other currency pairs.

Trend-less market

During a ranging market we could use the interpretation explained above to trade off stochastics.

Divergence

Divergence trades are amongst the most reliable trading signals in the Forex market. A divergence occurs either when the indicator reaches new highs/lows and the market fails to do it or the market reaches new highs/lows and the indicator fails to do it. Both conditions mean that the market isn't as strong as it used to be giving us opportunities to profit from the market.
Stochastics can also be used to trade off divergences.

Price behavior

A price behavior can be incorporated into any kind of system or Forex strategy. When using divergences or overbought/oversold condition with a price behavior approach, the probability of success of our signals increases enormously. Why? Because price dictates at the end, how all indicators will behave, it also gives us a lot of information about the probable direction it will take in the future

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Forex Market Update - Forex Strategy Today's

By John Hardy Consultant/FX Strategist Saxo Bank

GBP breaking stronger vs. EUR and CHF after BOE cuts to 1.00%. ECB steady at 2.00% as expected.

JPY crosses zigging and zagging with no real conviction - should JPY longs be cautious here?

MAJOR HEADLINES – PREVIOUS SESSION

* New Zealand Q4 Unemployment Rate rose to 4.6% as expected and vs. 4.2% in Q3

* UK HBOS house Prices rose 1.9% MoM vs. -1.6% expected

* Germany Dec. Factory orders fell -6.9% MoM and -25.1% YoY vs. -2.5%/-24.5% expected

* Bank of England cut interest rates 50 bps to bring the rate to 1.00% as expected.

THEMES TO WATCH – UPCOMING SESSION

Events Today:

* Canada Dec. Building Permits (1330)

* US Q4 Nonfarm Productivity and Unit Labor Costs (1330)

* US Weekly Initial Jobless Claims (1330)

* US Fed's Plosser to Speak (1330)

* Canada Jan. Ivey PMI (1500)

* US Dec. Factory Orders (1500)

* US Jan. ICSC Chain Store Sales (no time given)

* Switzerland SNB's Hilebrand to Speak (1730)

* Us Fed's Bullard to Speak (1800)

* US Fed's Stern to speak (1900)

* Australia Jan. AiG Performance of Construction Index

* Japan Dec. Leading Index (0500)

* Switzerland Jan. Unemployment Rate (0645)

Market Comment:

Equities tried to stage a rally yesterday as the ISM Non-manufacturing number recovered a couple of points rather then sinking further. Still, the number represents a service sector in strong contraction, and services are still the majority of the US economy. Also on a positive note, the ADP number was slightly less bad than expected. But the numbers were not sufficient for the market to really hang its hat on and the rally in risk crosses quickly faded later in the North American session.

GBP followed up stronger versus its European counterparts yesterday and this morning ahead of the Bank of England meeting. The Bank cut 50 basis points as expected, bringing the rate to a new record low of 1.00%. As a small minority were looking for a 100-basis point reduction in rates, the news can be considered marginally GBP-positive, all else being equal. The immediate reaction saw the 0.8800 key support level coming under fire and even falling as this is being written ahead of the ECB press conference. The BoE also released a series of statements indicating its negative view on the situation, but did note that the drop in the pound and existing fiscal policy should help to give a boost to the economy, even if "the transmission mechanism of the monetary policy was impaired" [and if that is the case, then the market starts to ponder the whole quantitative easing line of logic]. All in all, this latter note suggests some degree of applying the brakes to the otherwise dovish trajectory and with GBP pushing through key levels, could be triggering a sustainable uptick in GBP against the other major currencies.

Also GBP supportive was the odd Nationwide housing numbers from December, which suggested that UK home prices ticked up in December even if they were still off over 17% from a year earlier. This could simply be due to a rise in activity due to the lower prices, a bit less panic in the forced sales market, etc...rather than a sign of imminent recovery. Still, the shocking pace of the previous drop may not be repeated any time soon, and the leading RICS indicator suggest that a lower percentage of agents are seeing housing prices falling, so we could be in for a couple of months of relative stability.

The ECB left rates unchanged as expected as today's meeting came only three weeks after the previous one. Watch Trichet for further developments. He is likely going to express a reluctance to move rates much lower, but that the ECB will do what is necessary...etc and yawn...As with last time around for the ECB: is there really any EUR bullish outcome?

JPY crosses are looking less heavy than one would have suspected they would with the marked weakness in equity land late yesterday. In the broader picture, considering the mayhem that this global slowdown is creating for Japan's export-driven economy, we are considering noting some caution for JPY longs here, meaning that we need to see the crosses proving themselves lower before we would consider jumping aboard, as it seems they are having a difficult time working up a head of steam. GBPJPY, one of the most popular trades (on the short side) in the strong JPY cycle, has now rallied almost 10% from its lows on the year below 120.00. AUD and NZD and some of the EM currencies are looking a bit resilient here as well and risk spreads are simply in the doldrums. With the fear levels seeming to fade somewhat, it appears that back and forth sloshing and a treacherous ranging environment with false breaks is as likely as a new big bear trend here in the risk aversion-themed FX crosses....stay tuned and watch the 800 level in S&P500, as this is a big trigger event across markets.

NOK continues to look strong after the bank cut rates 50 bps yesterday, a marked sign of strength in this market as we suspected there was some chance of a consolidation higher yesterday in the wake of the Norges Bank meeting. Could we be hitting a fifth wave already for the decline from the 10+ top? If so, this wave could take us all the way to 8.50, where the 200-day moving average might be in a few days time from its current 8.475 level

More analysis: Saxo Bank Market News & Analysis

Risk Warnings:

Saxo Bank A/S shall not be responsible for any loss arising from any investment based on any recommendation, forecast or other information herein contained. The contents of this publication should not be construed as an express or implied promise, guarantee or implication by Saxo Bank that clients will profit from the strategies herein or that losses in connection therewith can or will be limited. Trades in accordance with the recommendations in an analysis, especially leveraged investments such as foreign exchange trading and investment in derivatives, can be very speculative and may result in losses as well as profits, in particular if the conditions mentioned in the analysis do not occur as anticipated.

Please read our full Analysis Disclosure & Disclaimer at www.saxobank.com/analysis/disclaimer.

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Effective Strategies in Forex

Starting out in the Forex world of trading can be quiet daunting. So we have put together some of the most powerful strategies to help your forex trading.

So you are serious about profiting in forex trading, then you need to watch forex trends which are short term.

Here we are going to give you a 3 step simple method which if you use it correctly, will help you catch every superior forex trend and lead you to long-term term currency dealing success.

New and inexperienced traders don't try to follow the trend for forex lengthier term - instead they try forex scalping or day trading hoping to grab short term profit. These methods focus the trader on small moves and they hope to catch small profit however as most short term moves are random, this leads to equity eliminate.

Also make sure you are using the Best Forex Broker

The other alternatives are swing trading and long term forex trend following and this article is all about the latter method. If you look at any forex chart, you will see long-term term trends that last for months or years. These moves can and do yield serious profit - present we will outline a simple method to get them.

Breakouts

By far the best way of catching the serious moves is to use a forex dealing strategy based around breakouts. A breakout is simply a move on a forex chart where a new high or low is made and resistance or support is broken.

It's a fact that most leading moves start from new highs or lows.

While it might appear that you are not buying or selling at the greatest level, you are in terms of the odds of the trend continuing. Most forex traders make the mistake of waiting for the breakout to come back and get in at a better price but these traders never get on board. The grounds for this is if a breakout occurs, then you have a new strong trend and a pullback is not very likely to occur.

Most traders don't buy or sell breakouts and that's exactly why it's such a powerful method.

The only point to keep in mind is a support or resistance which is ruined, should be valid and that means at least 3 points in at least 2 different times frames. The more tests and the greater the spacing between the tests the more valid the level is.

Confirmation

Of course not every breakout keeps and some reverse, these are false and can cause losses. You therefore need to confirm each move. All you need to do to achieve this is to put a few momentum indicators in your forex trading system to confirm your dealing signal.

These indicators give you an estimation of the strength and velocity of price and there are many to choose from. We don't have time to discuss them here (simply look up our other articles) but two of the greatest are - the stochastic and Relative Strength Index RSI

Stops and Targets

Stop points are easy with breakouts - Simply behind the breakout point.

If you have a serious trend then you need to be careful you can milk it, so don't move your stop to soon and keep it outside of normal volatility. If it is a huge move, trailing stops should be held a long-term way back and the 40 day moving average is a good level to use.

You have to keep in mind that when the trend does eventually turn you are going to give some profit back. You don't know when the trend is going to end, so don't predict.

It's ok to give a serious back, as that's the nature of trading forex. Keep in mind if you got 50% of all leading trend you would be very rich. When you are long-term term trend following you have accept giving a bit back and taking dips in open equity as the trend develops - this is noise and does not affect the long term trend.

The above is a simple way to trend watch forex and catch the high odds moves that yield the serious profit. If you are learning forex dealing and want a simple method that is robust and will help you get every major move, then you should base your dealing on the above method.

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