The Stochastic Oscillator
Everything Comes With A Caveat
I am a student of technical analysis, trader, writer and binary options researcher. I am not a licensed broker, dealer or advisor. This is intended as an educational resource and discussion of stochastic indicator trading strategy. It is not a recommendation to buy, sell, trade or otherwise engage trading. I welcome comments and criticisms. Please post those below in the comments section.
What Is Stochastics
Stochastic is an unusual word but the meaning is even more. Stochastic is a word derived from the ancient Greek word stokhastikos which means "take a guess at". In terms of binary options and market speculation stochastic is an oscillator. Oscillators are visual representations of price movements displayed as charts or histograms below charts of stocks. They (oscillators) are also used with financial indexes, bonds, currencies and futures. These oscillators help technical analysts judge things like market direction and strength. They can be used to pick entry and exit points with relative success, especially when used with a disciplined approach.
Stochastic can also mean randomly determined, a definition that may seem counter to taking a disciplined approach to trading. What stochastic assumes is that a direction can predicted with a certain amount success while the number and types of steps it takes to get there is random. So long as the steps trend in the predicted direction it does not really matter what kind of steps are taken, does? The stochastic indicator uses an equation that compares the opening and closing prices of a traded financial instrument. It produces two lines when graphed, %K and %D. %K is the shorter term line and by nature the more volatile. %D is the longer term line and provides the basis for signal taking.
These two lines can be analyzed many ways and in any time frame. The best way to use stochastic, or any oscillator, is in multiple time frames. I use three in this technique, hence the name Stochastic Triple Cross. The %K line will move back and forth, seemingly at random, crossing over the %D line. The %D line moves much slower. The pair of lines are often compared to a man walking a dog on a leash. The man(%D) is walking where he wants to go but the dog(%K) will bounce back and forth along the way. Sometimes he pulls with the man, sometimes he pulls against him. This is much like a financial market. While trending in one direction it can be pulled or pushed by short term events and news. This noise is like the dog pulling the man.
Stochastic Long Term Analysis
More On Stochastic Stragtegy
My friend Michael Hodges is a great binary options trader. He uses stochastic as part of his daily analysis and has written some great information about how to apply it to binary options trading.
Use Stochastic For Long Term Analysis
The first step is to analyze the primary trend. This is the major trend of the underlying market, not counting the secular trend. Stochastic can be used to determine trend and potential market reversals in several long term time frames. I use charts of weekly closing candlesticks. One good thing about stochastic and market reversals in the primary trend is that you can still get good signals for day trading even if the reversal fails.
The Long Term Trend
To start use a trend line connecting at least three points to determine the primary trend. The trend line I have drawn connects 7 points over 5 years. I know it's easy to sit here and draw this line now, 5 years later but this trend line could have been anticipated. Drawing the line in 2009 connecting the two peaks present would project the same line it does now. Those peaks are not enough for a confirmed primary trend but it is good enough to start looking for other signs of market bottom or reversal in anticipation. Looking at the stochastic you can see a clear divergence in price occur in early 2009 along with these two peaks. Divergences are great ways to spot bottoms in every time frame and help to confirm the 2009 bottom.
The bounce in early 2009 is the first sign of a new uptrend and a signal to start looking for signals. So, from 2009 forward we will only be taking buy signals until the primary trend is reversed. These signals are confirmed many times and leave this chart in a bull trend. Signals on the shorter time frame charts should only be taken in the same direction as the primary trend.
Signals are generated when the stochastic indicator %K turns up from beneath and crosses above %D. Any time the lines crosses up from beneath during a bull trend a signal is generated. A strong signal occurs when both are pointing up, a weak one when %D is pointing down. As long as %K is above %D the buy signal is valid in a shorter time frame. These signals weaken and end as %K rolls over and then crosses back under %D. On this chart %K is beneath %D following a strong signal. It is in good position to make a new signal but its not quite there yet.
Stochastic Signals On Daily Chart
Stochastic Gives Signals On Daily Charts
- Once a buy signal is identified on a chart of weekly closing you can move down to charts of daily closing. On this chart look for ideal entry points for longer term trades and other shorter term trading opportunities. Because the long term trend is up only trade up on this chart, the same is true in reverse.
Signals on this chart are taken in the same way and same direction as on the longer term chart. When %K moves below %D and then crosses back over it generates a buy signal. These signals can be taken every time until the long term signal closes. Signals on this chart should only be taken when the lines are crossing. Also like the weekly charts this buy signal stays valid in a shorter time frame until the signal weakens and closes. Bullish signals would be reversed if the primary trend was bearish. A signal would generate is %K crossed below %D.
On this chart the last buy signal on the weekly charts begins the week of December 3. In the weeks prior to December 3rd there is a sharp pullback below the trend line. This pullback is a warning of weakness but it also comes with a weak buy signal on the stochastic. This turned out to be a profitable signal but a risky one none the less. There is another signal the week of December 3rd and then a stronger one the following week. regardless, all three signals are profitable over the span of a few days and weeks. A long term position could have been entered with either signal but short term positions should only be entered on the strong signal. Since then several more signals have been generated and all were profitable.
Stochastic Signal On Hourly Charts
Stochastic Cross Signal On Short Term Charts
When there is a buy or sell signal appearing in the long term and the intermediate term then you can narrow the focus even more. I use charts of hourly closings at this level. This allows for day and day to day signals to appear. Lets first look at the previous chart, starting with the signal on 2/7 and the weak signal on 3/1. The first is a better signal but it wasn't the first in that series it wasn't as strong. The market moves up, but slowly over a few days. The next signal, which is much earlier in the series, is sharper. This signal comes with more risk and is harder to catch.
Now lets look at those same signals on a chart of hourly candles. The same rules apply as in the earlier time frames. As long as the primary trend is up only bullish signals are taken. If the primary trend is down only bearish trades. Following the 2/7 signal on the daily charts there are three signals before the final stochastic divergence signals get out and stop trading. There are also two follow up signals on this chart before the next signal on the daily chart occurs.
The weak signal on 3/1 results in 3 hourly signals as well. These signals end with a stochastic divergence and a bearish candle signal. This signals time to stop trading in this time frame, pullback to the next time frame and see what it looks like. The daily chart above looks like the current rally is extended. It's time to wait for the next signal. The chart above that is extended as well but still bullish and in a good position for signal to form. The current analysis would be to wait for a signal on the daily charts before using the hourly chart any more. At that time the weekly chart should be consulted and then go on from there.
What Are Binary Options
Binary options are a fixed return trading vehicle with growing popularity. They offer traders the chance to speculate financial markets with less risk than other methods. Binary options only have two outcome, all or nothing. You can only lose what you trade. Other types of options, especially futures and currency, have unlimited risk even with stop loss orders in place.
What Are The Best Binary Options Brokers
There is a lot of debate over this question. I don't think it will ever be fully answered because of just how fast the industry has been changing. It also depends on where you live. There are quite a few brokers I will call "off shore". This is because they are internationally based, usually in Cyprus or other European country. Of these, there are numerous reputable brokers. All brokers based in Cyprus are required to be CySEC regulated, a standard that is attracting other brokers to the CySEC fold. Some, like Banc De Binary are also regulated by FSA, the Brittish Financial Services Authority.
I have used two offshore brokerages with success and can recommend them to others.
- 24Option - 24Option is a great platform for day trading with expirations as short as 60 seconds. The also have one touch and boundary options.
- Anyoption - Anyoption is my favorite off shore broker. Great for traders with a little longer outlook. Expirations range from hourly to end of the day, week and month. They also are the first off shore broker to offer 0-100 options. This type of binary option is the one that most closely resembles U.S. regulated options.
- NADEX - The best avenue for U.S. based traders. The off shore brokers are still good but until they are compliant and regulated by the CFTC and the SEC there are still risks. NADEX binary options are a little different than European style binary options.
Devika Primić from Dubrovnik, Croatia on March 09, 2013:
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