It often happens that an asset price is getting overbought or oversold, an oscillator shows an attractive signal to enter, but the price action goes in the same direction. As a result, a false trading signal from a trusted indicator, which used to bring lots of profits previously, causes losses instead of profits. How to avoid such a situation? What are the key parameters to find market traps and identify false signals from technical indicators? This trading system is aimed to answer those questions.
Experienced technical analysts admit that a filter is needed for every single indicator, even the most reliable and effective one. The main reason is that market players sometimes are getting affected by some fundamental news or unpredictable events, which cause a massive flight to safety, for example, or prompt speculators closing deals much earlier than long-term targets are achieved. In this case, the priority of the technical analysis is getting lower as psychological and fundamental factors drive the market. Besides, technical indicators have a lagging nature as their mathematical formulas are based on calculations of past price action, but they do not take into account rapidly changing market conditions. But what’s the most efficient way to implement a filter for let’s say an oscillator?
The answer is simple. Traders should add the same oscillator with a different period. The Double Stochastic Forex Trading System is based on two Stochastic oscillators with modified periods to filter each other. The faster oscillator has modified settings of 8.5.3 instead of default 14.3.3. A more frequent analysis allows calculating fast price swings and this approach is aimed to underline the market’s volatility and momentum. The slower Stochastic had a longer period of 14.7.3, while the overbought zone is set to the level of 80%, and the oversold territory is at the mark of 20%. The faster indicator will warn a trader about a potential reversal in the chart, while the slower one will confirm the trading signal, showing when it’s time to pull the trigger.
The main action is a crossover of two Stochastic lines in overbought territory for short positions and oversold zone for longs. Once the faster oscillator appeared below the level of 20, a trader starts monitoring the performance of the slower Stochastic. Once it performs the crossover, long positions should be opened. For shorts, the condition is the same but mirrored as traders should wait until the market will signal an overbought status, and both oscillators will cross the lines.
When it comes to choosing an asset to trade with this system, the best choice is a cross-rate as such an asset class is vulnerable to many reversals during the trading session. For instance, we’ve chosen the GBP/CHF cross and a one-hour chart to show the system in action. Shorter timeframes are also applicable but the frequency of trading signals would be higher. Exit conditions depend on the distance the price has gone after the entry point, the timeframe was chosen and individual money management rules. The chart below illustrates how the faster oscillator warns about possible reversal, while the slower one confirms the action.