Advanced Stochastic Oscillator BO Strategy

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Video Transcription:

Hello, traders. Welcome to Day Trading Binary Options. In this lesson, you
will learn how to trade with a stochastic oscillator, and we will show you
all of its advanced setups and how to look for them.

First of all, what is the stochastic oscillator? The stochastic oscillator
is a simple momentum indicator. This indicator doesn’t follow price. It
actually follows the speed of price, which we call momentum. The faster the
price is going, the higher the momentum and the bigger the range in the
market. As a general rule, momentum shifts before price does. By using the
stochastic oscillator, we can anticipate price reversals.

How can we anticipate price reversals with the stochastic oscillator? Well,
this is simple. We already said it. Because momentum shifts before price
does, the stochastic oscillator will give us signals of [inaudible 01:02] before we actually see any fluctuations in price.

The stochastic oscillator oscillates between zero and 100, giving us over-
bought and over-sold readings to use to analyze price action. Over-bought
and over-sold readings can help us get in the main trend by spotting
corrections from the trend.

Of course, we can also use over-bought and over-sold readings to trade
larger ranges. The stochastic oscillator is a simple indicator, but at the
same time, a very complex one, in the sense that you can look for various
types of setups in different market environments. So let’s start with the
simplest one: the over-bought and over-sold conditions.

Over-bought readings are above the 80 level, for the 14-period stochastic.
The 14-period stochastic is the default setup for the stochastic, which is
the one we are going to be using. This means that the security is trading
near the top of its 14-day high/low range. Because the security is trading
near the top of its 14-day high/low range, it is over-bought, and this
level might be unsustainable.

On the other hand, over-sold readings are below the 20 level, for the 14-
period stochastic. This means that the security is trading near the bottom
of the 14-day high/low range. This is the opposite of the over-bought
readings. Here, the security is bottoming down. Because it’s trading near
the bottom of its 14-day high/low range, these low prices might be
unsustainable.

It’s important to know that over-bought readings are not necessarily
bearish, and over-sold bullish signals. This is because in a very
aggressive move either up or down, the stochastic oscillator can stay over-
bought or over-sold for a long period of time. The over-bought and over-
sold signals work best in clean arrangements. Let’s have a look at an
example.

This is the GVP/US dollar four-hour chart, and here we have a clean range.
Here, we have the bottom of the range. Here, we have the top of the range.
As you can see, when we reach the top of the range, the stochastic
oscillator gives us an over-bought reading, and then it consequently
dropped below the 80 level.

When the stochastic oscillator crosses the 50 level, which is around here,
when we take out this low or this area of support, we have a signal to buy
puts. On the contrary, here you can see that we have reached the bottom of
the range, and the stochastic oscillator is giving us over-sold signals, or
over-sold readings.

When the stochastic oscillator crosses above the 20 level and, of course,
ultimately above the 50 level, which is right here, we have a signal to buy
[inaudible 04:38] cable four-hour chart.

So as you can see, over-bought and over-sold readings are best used in a
ranging market. But as we already said, they can be used to get in the main
trend when a price is trending. We will see that when we go to the empty
floor platform. But remember, for the over-bought and over-sold signal to
be valid, the stochastic oscillator must cross below the 50 level on over-
bought conditions, and above the 50 level on over-sold conditions.

Now, the second type of setup we’re going to be looking for are
divergences. Divergences form when a new high or low is not confirmed by
the stochastic. This means that when price is making higher highs, and the
stochastic is making lower highs, we have a divergence. On the contrary,
when price is making lower lows, and the stochastic is making higher lows,
we also have divergence. This means that the new high or low is not
confirmed by the stochastic.

Now, a bullish divergence shows less downside momentum than can be
interpreted as a bullish reversal, because the new low is not confirmed by
the stochastic oscillator. We can certainly say that the bearish pressure
isn’t up at these levels. On the contrary, bearish divergence shows less
upside move that can mean that a bearish reversal might play. This is the
opposite.

Because the new high is not confirmed by the stochastic oscillator, we can
say that the bullish pressure is fading, and we have found some bearish
pressure that might turn things around for us. Always look for confirmation
of the reversal after divergences. Let’s have an example.

Here is the US dollar/Japanese yen four-hour chart. As you can see, we are
making higher lows, which are not confirmed by the stochastic oscillator
because we have flat lows or slightly lower lows. Now, this is what we call
a bullish divergence. A bullish divergence is found at the bottom of a down
move. When we don’t have any confirmation, when the new high is not
confirmed by the stochastic, we can say that we are diverging from price on
a bullish [inaudible 07:29].

The confirmation that we always look for is . . . We need to take out the
previous high or the previous area of resistance. Right here, we broke with
this area of resistance. So we have a signal to buy put [inaudible 07:46] on the US dollar/Japanese yen four-hour chart. This is the four-hour chart.
We can trade the weekly expiration options on this currency pair.

Let’s imagine that this is the 15-minute chart. We can actually trade the
hourly expiration options, and we would have expired in the money. On the
contrary, here is an example of a bearish divergence. As you can see here,
our price is making new highs, which are higher highs, and the stochastic
oscillator is making lower highs.

Once we break with the structure, the up structure . . . Remember that the
up structure means that we are making higher lows. When we break with the
up structure right here, and we make a lower low, we have a signal to buy
puts on the US dollar [inaudible 08:44]. In this case, of course, we expire
in the money.

Now, this is what we call classic bullish and bearish divergences. What
we’re going to look now for is the new or the advanced setups to call tops
or bottoms, and these are bear and bull setups. These are other forms of
divergence to predict tops and bottoms. A bull setup is the opposite of a
bullish divergence. The security makes lower highs, and the stochastic a
higher high. The bear setup is the opposite of a bearish divergence. The
security makes a higher low, and the stochastic a lower low.

Now, always look for confirmation of the setup. This is what we call the
bounds. On the bear and bull setups, we don’t look for support or
resistance breakouts. Actually what we look for is stochastic bounds, and
we are going to look at this on the following example.

Here is the US dollar/Euro/US dollar daily chart. As you can see, at the
bottom of this down move, price made a new high, which is a lower high. The
stochastic oscillator made a higher high. This is what we call a bull
setup. When we have the bull setup, we need confirmation, and the
confirmation is the bounds.

You can see that after the divergence, the stochastic oscillator bounced
back below the 50 level to move up. Here, when we have the bounds, we have
a signal to buy calls on the Euro/US dollar, after a bull setup.

On the contrary, we have the bear setup. Here’s the Euro/US dollar daily
chart. As you can see, price is making higher lows, but the stochastic
oscillator is making lower lows. After the setup is confirmed, we wait for
the bounds, which is this one. When we break below the low, we have a
signal. We have a signal right here to buy puts on the currency pair.

So these are the three kinds of setups that we are going to be looking for
with the stochastic oscillator. Let’s go through some considerations.
Always use immediate support and resistance levels to confirm moves before
you buy your options. The stochastic signals can be traded with any
instruments and any timeframe. The higher the timeframe, the more accurate
the signals are. In an uptrend, look for over-sold readings to buy calls
and trade the direction of the move. In a downtrend, look for over-bought
readings to buy puts and trade the direction of the trend.

Now, let’s go to the empty floor platform. Okay. Here’s the empty floor
platform. Let’s start with the New Zealand dollar/US dollar. Here’s the New
Zealand dollar/US dollar one-hour chart, and we have already plotted the
stochastic oscillator. For those who don’t know how to do it on the empty
floor, just go to your ‘add indicator’ button, then oscillator, then
stochastic oscillator, and you choose the default settings for the
stochastic oscillator.

Now, the first thing we need to look for are over-bought and over-sold
levels. Okay? Right now, we are below the 20 level, which means that market
conditions are over-sold. But the difference between this and the slides
that we presented to you on the lesson is that right now, we are in an
uptrend. I know we told you that over-bought and over-sold signals are
better used on big ranges or team ranges. But we also told you that over-
bought readings and over-sold readings are excellent to jump into the main
move.

As you can see, we already have moved from this low to this high, about 300
pips. If you look at what price action did and the stochastic both did, you
can see that after this correction right here, we had another over-sold
reading. Let me just put a square right here and a square right here. You
can see that we actually corrected to a previous area of support. When we
corrected to this area of support, we were at over-sold readings.

This means that we are not actually . . . Well, we didn’t reverse from the
main trend, but we actually just corrected. This spot right here gives us a
signal to buy calls and to trade the main move. Okay? Right now, even
though we don’t have any levels . . . Well, let’s go to a four-hour chart,
and let’s see if we can find a level right here.

Well, we found this level where we picked, and we have another one right
here. Right? Which is this one. Okay? Now, if we go back to the one-hour
chart, you can see that actually we are somewhat in the same spot as we
were down here. The correction is not as deep as this one, but from this
high to this low, this 50-pip correction gave us an over-sold reading,
which means that it is safe to assume that we are just testing this
previous resistance and support before continuing with the up-move.

So this would be a great opportunity to try to buy calls on the New Zealand
dollar/US dollar, once the stochastic crosses above the 50 level. I mean,
you can . . . There are two types of traders: the aggressive traders and
the conservative traders. In my case, I’m more of a conservative trader
because I do wait for confirmation. In this case, the confirmation would be
to take out this area for resistance and to cross over the 50 level. But
this is clearly a setup to be watching because we found an over-sold
reading on an up-move. This is what I was telling you to look for when we
are trending.

Now, let’s see. Let’s go. Well, let’s take another currency pair. Let’s see
if we can actually find some more setups or divergences. Let’s look for
divergences. Okay? It’s always fun to look for divergences because they
usually work very nicely. I do like to trade the one-hour chart or the four-
hour chart because I’m more of a string trader. I really don’t day trade
Forex. But if you’re more comfortable day trading Forex, it’s up to you.

But I’m going to show you these divergences in a one-hour chart, and of
course you can look them in the 15-minute chart or 30-minute chart or five-
minute chart, or whatever timeframe you analyze price action on, but
remember to trade expirations accordingly.

Now, here we have a very nice divergence price making here, higher highs,
and the stochastic oscillator is making lower highs. So we have spotted the
divergence right here. What’s next? The next thing we need to do is to wait
for the confirmation. What’s the confirmation? The confirmation is the
breakout or the break of this up-structure. We break through this up-
structure right here.

If this week is any indication, we know that we have rejected these levels,
and we might shop for a little while. Okay? So you need to choose your
spots to trade off divergences. In this case, I wouldn’t have traded this
setup.

Let’s go back to see if we can actually look for something a little more
interesting. Well, this is actually very interesting because we are testing
these highs right here. Okay? Remember that resistance are zones, and they
are not just lines.

So, what we did here is we drew a line from this low to these highs, and a
line from this low to this area of support right here, which we tested with
this week right here. Now, why am I showing you this? I’m showing you this
because even though we are not in a range, we don’t have any divergence, we
are in an area of heavy resistance. Okay?

Even though we have chopped all the way here, you can actually see . . .
I’m sorry. Let me get rid of this. You can actually see that this rejection
was very strong. So what do we have here? We do have a weak high and, of
course, an over-bought reading. Now, when we cross back below and we take
out this low right here, we have a clear signal to buy puts on the
Euro/GVP, because this little up-structure is broken in two. We have
massively rejected this level of resistance.

So, always use resistance and support levels when trying to trade ranges.
This is not a very clean range, but it is a range, nevertheless. When
trading divergences or bear and bull setups, always look for a
confirmation.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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