The forex market offers lots of opportunities for trend traders but it offers even more for those who know how to trade less directional patterns. All trends in forex come to an end or at least begin to consolidate in price patterns that form support and resistance areas. Using the stochastic indicator when price is contracted in one of these patterns can help you time your entries and take advantage of price bounces back and forth.
Instructions:
1) Open a stock chart at Freestockcharts.com and then pull up the currency pairs on the price quote screen. Insert a fast stochastic indicator on the lower quadrant of the price chart with a 12-period reading. Make sure that the two moving averages, the %K and the %D, are set to levels 3 and level 5 respectively. You want the stochastic set to be a leading indicator of when price action reaches an oversold or overbought position in a support or resistance area. For this trade setup, a fast stochastic reading at 20 or below is oversold while a reading of 80 or above indicates an overbought position.
2) Select a daily time period for the price chart and then go through the various currency pairs to find price action that is consolidating between two price points in a contracted pattern.
3) Scan these key areas of support and resistance on the daily price chart and coordinate the price with the readings on your stochastic indicator. As price approaches the support level be sure to verify that the stochastic has an oversold reading. For a resistance level, you want to check the stochastic to confirm that it has an overbought reading.
4) Prepare to enter the trade when price approaches a key level of either support or resistance. Once price enters one of these areas and is in a confirmed stochastic overbought/oversold reading then you will need to prepare to enter when the trade is triggered.
5) Implement a position once price begins to reverse its trend and moves over the high of the lowest low established by a price bar in a support level or moves under the low of the highest high established by a price bar in a resistance level. Once a trade is initiated, use the resistance level as the price target for a support trade and use the support level as the price target for a resistance trade.
Tips and Warnings:
You can filter your trade by only trading in the direction of the dominant trend. For example, if the dominant trend was up before price began getting contracted within a tight pattern, just take the support trade in the direction of the initial dominant trend. Trends are several times more likely to eventually continue in the direction of their original move unless acted upon by a larger force to reverse the original trend.
While trends are likely to continue they do end and can end abruptly when acted upon by a larger outside force. This larger force could be a wave of selling due to war being declared somewhere in the world, for example, and could prove disastrous for one of your currency pairs. Always use stops and, remember, forex is extremely volatile so protect yourself with good risk control as well as low exposure in position size.
Source - eHow
