Mean Stochastic Forex Trading Strategy

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Mean Stochastic Forex Trading Strategy

I’ve been noticing that there has been some kind of divide among traders. Those who use price action and those who indicators.

In the past, indicators became the fad in the trading world. Everyone started to look for the “perfect” indicator. That elusive indicator that does no wrong. Some search for it as though it is the Holy Grail of trading. Some find their own Holy Grail, while many fail.

Lately, the search for the Holy Grail indicator has ceased for many, but many say there is a better way. It seems that price action trading has replaced all the excitement that was once surrounding indicators. Some say that indicators are lagging while price action isn’t. Some say price action trading is better because it is more immediate.

While these thoughts have a grain of truth in it, I don’t think this is totally true. When you come to think of it, both price action and the indicators are all derived from the price chart. A price chart which is also information coming from the past. I don’t care whether it is on the daily chart or the minute chart, or even on the tick chart, it is still a record of the past. This means that both indicators and price action are lagging. Only information on the Depth of Market is information that could still affect the future. Before you go off to search for the latest Depth of Market strategy, pause for a moment. Depth of Market on the forex market is just way too much information. The forex market is just too big, the pending orders on the order books will just be way too bloated and quick to move to be deciphered by the human mind.

Even though indicators and price action are lagging information, don’t be quick to throw them out the window. Trading is a Game Theory type of business. People make decisions based on what they think others are thinking. And because many people are looking at indicators and price action, many will be taking action based on them. With this in mind, we could use information from indicators and price action, which we think many will be taking action on. The more basic, the more people look at it. The more people look at it, the better.

For this strategy, we will be marrying the two, a very basic indicator and a very common price action candlestick pattern – the Stochastic indicator and the good old pinbar candlestick pattern. Both are excellent for spotting potential reversals, and both are widely used among traders. The perfect match.

The Setup: Mean Stochastic Strategy

This strategy is a combination of a very basic mean reversal strategy based on the Stochastic indicator and the popular reversal pinbar candlestick. Having in mind that both are indications of probable reversals, this combination will have a higher probability than if they were used as a standalone strategy.

Timeframe: 5-minute chart

Buy Entry:

  • Stochastics should be below 20 indicating an oversold market condition
  • Fast stochastic should cross above the slow stochastic
  • A bullish pinbar candle should form
  • Enter a buy market order on candle close

Stop Loss: Set the stop loss at the low of the candle

Exit: Close the trade as the slow stochastic crosses above 80

Sell Entry:

  • Stochastics should be above 80 indicating an overbought market condition
  • Fast stochastic should cross below the slow stochastic
  • A bearish pinbar candle should form
  • Enter a sell market order on candle close

Stop Loss: Set the stop loss at the high of the candle

Exit: Close the trade as the slow stochastic crosses below 20

Conclusion

This is a basic mean reversion strategy that exploits the power of confluence. This time the confluence is between a traditional stochastic indicator which is widely used by many traders, and a pinbar candlestick pattern which many traders are familiar of and use as a trigger. Having this combination ends up with a high probability trade.

Because this strategy is a pure mean reversion strategy, it doesn’t take into account any information regarding the trend. Still, even without considering trend direction, because of the strong individual probabilities of both the stochastic and the pinbar, this strategy still ends up having a high probability.

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