What is RSI and Stochastic Forex Trading System
Short-term trading systems are popular among retail traders with comparatively low equity. However, the latest data shows that large investment banks and financial institutions use those types of algorithms for intraday trading. The key advantage of such trading methods is that reversals and changes in the trend direction happen more frequently on timeframes less than 1 hour than on four-hourly charts, for instance. At the same time, ultra-short-term charts are full of unpredicted price action which could be modelled by any mathematical formulas, especially when it comes to thin trading hours with low volume and volatility. This is why it is not recommended to focus on charts shorter than 15 minutes. As a result of those conclusions, we left with a choice of 3 timeframes: 15-minutes, 30-minutes and one hour. Some traders even analyse those three charts for one single asset at the same time. That helps to determine correct price levels, limit losses and boost profits.
How to Use RSI and Stochastic Forex System
The next steps are to choose useful technical indicators aimed to provide accurate trading signals. As you could already guess from the article’s header, we’ll talk about oscillators today as the trading system is keen on searching for reversal patterns. The Relative Strength Index is widely-used multi-purpose oscillator with several additional features besides just overbought/oversold levels. Those patterns might include confirming and reversal divergences, by-trend bounces and momentum indicators. However, we would limit RSI’s strength in this particular trading strategy with one advantage which shows completion of the reversal sentiment. The period should be changed to 13 as we consider short-term charts, overbought and oversold levels should be shifted to 70 and 30, respectively.
The second technical indicator is Stochastic. That’s also an oscillator, but its nature and mathematical formulas are different from the RSI. Stochastic effectively points to overbought/oversold levels as well. However, we modify the default settings (to 11,3,3) and monitor the level of 50%, which shows the trend’s strength and direction. Those traders who do not trust Stochastic or prefer avoiding the combination of RSI and Stochastic, might consider adding another tool - ADX and DI. We’ve described it several times. The main idea of the second indicator is to show the momentum as the RSI will determine the trend direction. The ADX threshold might be shifted to the range of 20/25 as we would not like to see too many fake signals. The period range is 11-13 bars; traders might try different combinations for several currency pairs or other assets.
The entry conditions are simple. We find a moment when RSI crosses overbought level 70 from below, reverses and goes back to average rates below 70. If at the moment of the second cross, Stochastic oscillator is below 50%, then we open short positions. For the bullish reversal, conditions are the same by the opposite. RSI has to slide below the level of 30, stay there for a while, signalling oversold territory, reverse and go back above it. If the Stochastic oscillator is above the 50% level at that moment, then we open long positions.
If you like this strategy, you might also be interested in this Guppy Trading
Exit rules usually vary. They depend on the asset, current market conditions and volatility. Traders could consider set pre-determined take-profit orders with a fixed number of pips, targeting certain price levels. Another option is a trailing stop. Money and risk management rules apply.