How to use Stochastic Oscillators for Scalping Forex
Hello, traders. Welcome to the Scalping Course, and the second module: “Getting Started: The Backbone of a Scalper.” And in this lesson, we are going to talk about fast-paced oscillators and the reason we are going to talk about fast-paced oscillators is because we are trying to create a very unique and a very complete scalping system. We are going to be using oscillators in this scalping system, and we are not going to use the default parameters but we are going to use faster oscillators.
Now let’s start by talking about why do we want to use oscillators. Whenever we decide to take a scalp, we are going to do it at very extreme levels. And the reason we want to trade only extremes is because we want to look for spots where the market has overextended itself. This means that we only want to sell extremely overbought markets, and we only want to buy extremely oversold markets. And the reason is because we are looking for the best possible trading setups and the best possible risk to reward ratios. And of course we want price to react quickly to our levels, and when we are looking for these extremes in the market is where we are going to find these spots.
Now of course oscillators show you extreme levels in the market where price has overextended itself and/or the current price cannot be sustained. And we are looking for a deep correction or/and an overall market reversal. So these spots are going to give us these great entries either to buy or to sell at overbought or oversold levels.
So why do we use fast-paced oscillators and not the default parameters with the oscillators? Well, fast-paced oscillators are oscillators that we use with a lower period than the default one. The default parameter is 14 periods, and we are going to use a 5-7 period RSI, MACD, or Stochastic. It doesn’t matter which oscillator you are going to use. We are going to use between 5 and 7 period, and we are going to go on this lesson through both of these settings and you are going to choose the one that works for you. And the reason why we are going to use 5-7 period RSI, MACD, or Stochastic is because we want them to react very quickly because of the timeframes we are trading from. And of course because we are scalping, we want a quicker reaction to our trades.
Now we are also going to use different overbought and oversold limits than the defaults ones. Oversold is going to be under 20 and overbought is going to be over 80. Normally the default settings are oversold under 30 and overbought over 70. And the reason we are going to change these parameters too is because we really want only extremely oversold and overbought markets to trade from.
So there’s two things we need to understand here. One we are going to use a lower period oscillator because we want it to react quickly to these levels, and we are going to use a higher limit on oversold and overbought levels, because we only want extremes in the market.
Now let’s go to a chart and let’s compare what a normal 14 period RSI looks compared to 5 or 7 period RSI. We are back and you can see we have two charts of the Euro/US dollars both on the three-minute timeframe. And on the upper chart, we have a 14 period RSI with an overbought limit above 70 and an oversold limit below 30. Now on the chart on the downside, we have a fast-paced RSI. This means that our RSI is set to 5 periods, and we have an above 80 overbought area and a below 20 oversold area.
Now just take a look at the difference between these two RSIs. Of course these RSIs looks a lot choppier. It will look a lot choppier because it reacts quicker to price movements. In this case, it doesn’t look as choppy but it doesn’t react as quickly as we want it to. And we are going to take a look at this area of strong price movements. Just let me take out a rectangle and show you the area that we are going to be looking at.
So this is the area we are going to be looking at, and we are going to be looking for a buy for this exact buy setup. As you can see, we have been tested… This is just an example of a buy using a fast-paced RSI. We have been looking for this zone of support throughout the entire session. You can see [inaudible 0:05:52] once, twice, and three times. This time, here, we came close to testing it. And here we really tested it and this candle gave us a very nice rejection pattern of this support zone. Of course we also have a resistance area right here, but we really are just looking for the buy setup that price action was giving us.
Now we are looking for a quick scalp, and this scalp should have given us 57 pips on the overall move and of course if we were just really scalping the market, we will have taken profits at around 27 pips, which is very good for a scalp, guys.
Now the reason we are going to use fast-paced oscillators because look at this. The RSI here, this is the 14 period RSI, and the 14 period RSI does not give us an entry. And this is very important, guys. When we are scalping, we are looking for very… We are looking for extremely oversold markets, and in this case, the RSI didn’t give us an oversold reading below 30, which means that if we are using the default periods, we cannot trust the RSI for scalping methods.
And if we take the lower chart, which we are using a 5 period RSI on it, we have absolutely the same setup. And remember that our oversold limit is below 20. And in this case, price tests the area and we have a setup. The RSI goes below 20 and then comes back above, meaning that we are truly in an immediate oversold market. And we can take the scalp and hit the previous resistance level right here for around 30 pips like we said on the above chart. And this is why we’re going to use fast-paced RSI when we are scalping the markets. If you are trading the longer term charts, it’s fine that you use the default settings, because you are not looking for as many setups as we are looking when we’re scalping the markets.
Well, this is another little trick that we are going to learn how to use is when you buy at an extreme level, you are going to sell your position at an extreme level, too. And you can see that if we were just following the RSI to close our position, the exact point of closing would be when the RSI goes above the 80 level, which means that we are in overbought territory, which will mean that this entire move to the upside would have ended and it would have given us a 60 pip profit on that scalp. But remember that we are going to learn how to use the RSI later on this course. This is just the backbone of a scalper. And the aim of this module is to teach you why we are going to use the indicators that we are going to use, and why we are going to use certain parameters and how we’re going to use them.