Stochastics Divergence and Pivot Line Strategy

Introduction

The strategy to be discussed today is a method of trading the pivot point levels using the Stochastics divergence play. The Stochastics oscillator is a momentum indicator and one of the ways in which this indicator works is by picking out price and indicator divergence. However for this strategy, we will use the pivot points as a further confirmation for the divergence trade.

The strategy can be used on all time frames, but longer time frames are preferred because they deliver more profits.

Indicators
The only indicators used here are:

  1. Automatic pivot point calculator
  2. The Stochastics histogram indicator. This is a modified version of the RSI which adds a histogram component to the indicator. This is a custom indicator which can be downloaded by clicking here.

The Strategy

This strategy is hinged on picking a divergence when the price action is at a pivot point. There are two kinds of divergences seen in forex.

The bearish divergence is seen when price is making higher highs when the Stochastics histogram is making lower highs. The price is expected to correct itself in the direction of the indicator. This is used for the short trade setup.

The bullish divergence is seen when price is forming lower lows when the indicator is forming higher lows. The price will correct upwards to reflect the direction of the trendline joining the histogram’s lows. This is used for the long trade.

1) Long Trade

The long trade setup occurs when we have the following conditions:

  • Bullish divergence occurring close to a pivot point, or just above a pivot point.

The common play is to trade off the bounce of price of a pivot point, as see on this snapshot.

Pivot_diverg2

In this snapshot which is a one hour chart for the USDJPY, we see the bullish divergence form as a result of price making lower lows when the Stochastics histogram is making higher lows. The trade is made by allowing price to move above the S1 pivot point (the closest pivot point) and trading on a bounce of that pivot point.

Stop Loss and Take Profit Settings

The stop loss is set at a few pips below the pivot point from where the trade is taken. In this example, this is the S1 level. The Take Profit is set at the next pivot point. If the price action breaks above this level, then the next target for the profit should be the pivot point above that, which in our example is set to R1.

2) Short Trade

The short trade setup occurs when we have the bearish divergence setup, with the price action forming higher highs when the trend line of the Stochastics histogram’s highs are actually heading lower.

Pivot_diverg1

In this snapshot which is a one hour chart for the GBPUSD, we see the price action closing right at the R1 area, which is just the right spot for the trader to setup a short trade.

Stop Loss and Take Profit Settings

The stop loss is set to just above the pivot point from which the trade is set, which in this case is the R1 pivot. The Take Profit is set at the next pivot level located below the entry point. However in this case, a bearish angle blasted right through the central pivot which would have served as the Take Profit area, but the breakout situation means that the pivot level below that area (S1) would serve as the natural replacement for the central pivot point as far as the Take Profit area is concerned.

Conclusion

The strategy works very well when all the rules are followed. Traders should try to ensure that the strategy is practised on demo before being applied to a live account. The simplicity of this system is what gives this strategy its edge. Feel free to use it, perfect it and profit from it.

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