Stochastic Oscillator Strategy

Hamish Raw
3rd June, 2013 - Posted by in Guides


Sto4 Stochastic Oscillator Strategy

 Introduction to the Stochastic Oscillator Strategy

Many successful binary options strategies are based on the Stochastic Oscillator but what exactly is this technical indicator all about and why is it so effective? A brief introduction is now presented in order to provide answers to these important questions. 

Essentially, the Stochastic Oscillator is an indicator that is very effective at identifying new quality trading opportunities especially if the price of an asset is range-trading. You can deploy this tool to trade all assets using the advised parameter settings of 14, 3 and 3. You can attain the best results if you install the Stochastic Oscillator on trading charts utilizing the daily time-frame or higher because of the quality of the statistics associated with them.

You should execute a CALL binary option whenever you detect the faster moving Stochastic rising above the slowing one and open a PUT binary option when the faster moving line drops beneath the slower one. A number of examples are displayed in the following diagram.

Sto1 Stochastic Oscillator Strategy

You will find that the Stochastic Oscillator strategies are very simple to implement and are good tools for identifying quality entry locations for new binary options. However, you need to appreciate that this indicator is primarily lagging in nature implying that it produces alerts that occur sometime after the market conditions have moved on. Consequently, the SO may create signals that can be misleading, especially if you are a novice.

The SO can also produce other problems, such as the following:  

  1. Price can progress quickly in its original direction despite the Stochastic Oscillator signifying a crossover. Such events can happen because the SO lags real-time implying that new market conditions could contradict its readings.
  2. Your binary options could become susceptible to sharp price surges, such as spikes, especially if your expiry times are quite long. Under such market conditions, as your Stochastic Oscillator strategy may respond too slowly to new stimuli, it may then fail to advise you quickly enough that corrective action is required.  

The Stochastic Oscillator fundamentally measures the rate of change of the price of an asset. When price exceeds the average rate of change measured by the SO, then overbought and oversold conditions are registered. These are important events because when they occur, the SO is advising that sharp retractions in price could be imminent. The SO records overbought conditions when it produces reading of 80 plus and oversold statuses with values of 20 or less.

Binary options strategies have been created that exploit these features of the Stochastic Oscillator. Here is such an example which works particularly well using expiry times of one hour and Forex assets. When utilizing such a set-up, you are advised to track price movements using the 5-minute time-frame in order to detect quality entry points.

When activating such a strategy, implement the following procedure.

  1. Locate an asset that is currently trading within a well-defined range denoted by a pronounced floor and ceiling.
  2. Select the 5 minute trading chart and install the Stochastic Oscillator
  3. The following 5 min chart for the USD/CHF demonstrates such an arrangement.

Sto2 Stochastic Oscillator Strategy 

Although you can detect the lines of the Stochastic Oscillator fluctuating within a restricted range, you will only be interested in those times when they are either below 20 or above 80. This is because these values signify oversold and overbought statuses.

Your basic mission with this SO strategy is to identify these conditions because they often prelude sharp retractions. This is especially so when the asset is range- trading, as demonstrated in the above diagram. When you detect such circumstances, you should execute the standard binary option in the direction of the retraction using a 1 hour expiry time.

The specific entry requirements are as follows. Once you identify either an oversold or overbought status, then wait until both lines of the Stochastic Oscillator have bounced back out of these two extreme conditions. As such, if price is overbought and then retracts back out of this status, this is an excellent signal to execute a PUT binary option. Similarly, rallies from oversold conditions are good opportunities to activate CALL options. Examples of both these situations are presented in the above diagram.

Tips for Using the Stochastic Oscillator Strategy

If you do intend to deploy a Stochastic Oscillator strategy, then you should be aware of the following important points. First, the above example demonstrates a SO strategy in its most simplistic form. As such, you can assess and incorporate additional techniques that could refine and improve its performance. For example, you could integrate other technical indicators into your strategy in order to confirm the readings of the SO. 

In particular, you must learn to detect the important oversold and overbought conditions with accuracy. You must only execute new binary options when price reverses out of them and at no other times. Do not let impatience force you to open premature trades as you could suffer severe losses.

Aim to apply this strategy only with assets that are definitely range-trading. You can apply SO strategies to trending conditions but make sure that you only open binary options in the direction of the dominant price movement, if you do so. This extra complication adds a level of difficulty that you are well-advised to avoid, especially if you are a novice.

So, how good are Stochastic Oscillator binary options strategies? Some traders claim that they have achieved impressive results by recording win-to-loss ratios as high as 85%. However, you should not consider such results to be the norm. Evidence does suggest that 70% is not an unrealistic target. With such an impressive track record, you are certainly well-advised to investigate the potential of Stochastic Oscillator strategies in more depth.

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