SD Stochastic Divergence Trading System

What is a Stochastic Oscillator?

The Stochastic Oscillator is a momentum indicator that shows the closing price in relation to highs and lows in a given period or range.

The Stochastic Oscillator consists of 3 parts:

1) %K – The %K is the current value of the pair being traded over the last previous given period of time. For instance, a %K setting of 8 will give the high low range over the last 8 bars and plot it as a percentage between 0 and 100.

2) %D – The %D is a simple moving average of the %K. Its purpose is to provide entry signals when it is crossed by the %K.

3) Levels – The levels indicate overbought and oversold areas. In the below system, I use the 80 level to mark the overbought area, and the 20 level to mark the oversold area.

How can it be applied to Forex?

The Stochastic Oscillator can be used to spot bullish and bearish divergence, it can also be used as an extra confirmation whenever you find a potential market turning point.

What does it mean if the indicator goes to a oversold or overbought area?

a) Whenever the Stochastic is over 80 its considered overbought, this indicates that price may go down but it can remain in 80 to 100 range for long time if negative sentiments do not come into the picture. In this case the uptrend can continue for a long time.

b) Whenever the Stochastic is below 20 its considered oversold, this indicates that price may go up but it can remain in 0 to 20 range for long time if positive sentiments do not come into the picture. In this case the downtrend can continue for a long time.

Summary:-

The overbought and oversold areas only indicate that the reversal would come but cannot indicate the time when it will happen. The bullish sentiment (uptrend) can continue its move up even after the Stochastic is in an overbought area and similarly the downtrend can continue its move down even when its in a oversold area.

System Name:-

SD Stochastic Divergence Trading System.

Markets:-

This system can be used on Currency's, Stocks and Commodities.

Brief Description:-

1) This system uses divergence as a key role for making any trade entry, the first thing you will need to do is wait for a specific chart pattern to form, once completed there should have also been divergence forming between the price on the chart and %K on the Stochastic Oscillator. Only then this trade setup will be considered valid.

2) This strategy can be used when the market is trending or range-bound.

3) Do not trade this strategy around any news events.

SD Stochastic Divergence Indicators:-

1) 5 pip Renko Brick

2) Heiken Ashi

3) Support & Resistance

4) Stochastic Oscillator - Settings (PeriodK - 7, Smooth - 3, PeriodD wont be used)

Long Entry:-

1) Wait for a Double Bottom to form.

2) There should be divergence developing from an oversold area.

5) Place your entry order 5 pips above the 1st green candle that formed.

6) Place your stop at the high of the Double Bottom.

7) Exit once the first reversal candle has formed.

Short Entry:-

1) Wait for a Double Top to form.

2) There should be divergence developing from an overbought area.

5) Place your entry order 5 pips below the 1st red candle that formed.

6) Place your stop at the high of the Double Top.

7) Exit once the first reversal candle has formed.

Trade Examples:

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Permalink Reply by joachim meier on July 5, 2012 at 1:34pm

hi simran, nice work. clear and easy to under stand. personally i would like it even better if you could use normal candle sticks, as most of us are using this, at least for discussions. but anyway beautifully done. have a good day

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Permalink Reply by Sardar Uddin on July 5, 2012 at 2:10pm

Simran, it the double top only condition for divergence signal or there are other patterns for divergence too

Why are you using Stoch (7,3) settings rahter then more commonly used Stoch (14,3)

Best

Sardar

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Permalink Reply by Simran Dhillon on July 5, 2012 at 3:42pm

Hey Joachim,

I have attached a few more setups using normal candlesticks, these setups took place around this week on the USD/CAD, When using this on a normal candlestick chart you should apply the following entry criteria,

1) The Double Top/Bottom must be around/testing a major support and resistance area.

2) Once the chart pattern is about to form, lookout for any candlestick formation patterns such as a bullish and bearish engulfing pattern or pin bars, these candlestick patterns will be our signal candle.

3) There should be a divergence developing from an overbought/oversold area.

4) Once the signal candle closes, you can neither enter into the trade only if you feel the R:R is good. Sometimes I usually place a limit order half way though the the signal candle, this will help reduce the risk on the trade. This entry order can only be valid for the next candle after the signal candle, so if it doesn't get hit delete the order.

5) Once you have achieved R:R of 1:1 move your stop to breakeven.

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Permalink Reply by Simran Dhillon on July 5, 2012 at 4:10pm

Hey Sardar,

You can also use this system on Double Bottoms. The high probability trade setups are when you get 3 important items coming together.

1) Price must be around key Support & Resistance areas.

2) The chart pattern must form around these important areas.

3) There should be Divergence on the Stochastic.

Have not really tried this out on other sort of chart patterns yet. But ill look into it. As for the settings for the Stochastic, it was just my preference but it should also work perfectly well on the commonly used setting 14,3.