swing trading with stochastic oscillator and candlestick patterns
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7/31/2015 Swing Trading with Stochastic Oscillator and Candlestick Patterns Trading Setups Review
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Home > Trading Setups > Swing Trading with Stochastic Oscillator and Candlestick Patterns
SWING TRADING WITH STOCHASTICOSCILLATOR AND CANDLESTICK PATTERNSBy Galen Woods in Trading Setups on 13 January 2015 Read more about Candlestick Patterns, Stochastic, Swing Trading
New traders make the mistake of treating candlestick patterns as simple trading signals. They do notrealize that most candlestick patterns are defined using the last two to three price bars and ignorethe price action context. Hence, it is crucial to combine candlestick patterns with other methods ofanalysis. In this swing trading strategy, we will use the Stochastic Oscillator to find high-quality candlestick patterns.
STOCHASTIC OSCILLATORThere are three types of Stochastic Oscillator: Fast, Slow, and Full. (Learn more about theirdifferences.)
For this setup, we will use the Full Stochastic Indicator. It has three inputs:
1. Look-back Period for %K (5)2. %K Smoothing (3)
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TRADING SETUPS RESOURCES PRICE ACTION COURSE
TRADING GUIDES SITEMAP
7/31/2015 Swing Trading with Stochastic Oscillator and Candlestick Patterns Trading Setups Review
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3. %D Moving Average (3)
The Stochastic (5,3,3) setting is sensitive, and hence suitable for finding short-term retracementtrades.
MORNING/EVENING STAR CANDLESTICK PATTERNSGaps are characteristic of daily charts that swing traders use. While gaps pose a risk for swingtraders, they reveal precious market clues.
The Morning/Evening Star candlestick patterns take advantage of these “clues”. Thus, we will focuson these patterns in this review. Of course, you can also use the Stochastic Oscillator toconfirm other candlestick signals.
7/31/2015 Swing Trading with Stochastic Oscillator and Candlestick Patterns Trading Setups Review
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TRADING RULES – STOCHASTIC WITH CANDLESTICKPATTERNSLONG SWING TRADE
1. Market is trending upwards.2. Stochastic (5,3,3) is below 20. (oversold)3. Buy once a Morning Star candlestick pattern is completed.
SHORT SWING TRADE
1. Market is trending downwards.2. Stochastic (5,3,3) is above 80. (overbought)3. Buy once a Evening Star candlestick pattern is completed.
For simplicity, you can use price action and the Stochastic Oscillator to judge the market trend. Referto the examples below.
TRADING EXAMPLES – STOCHASTIC WITHCANDLESTICK PATTERNSWINNING TRADE – SYY LONG SWING
7/31/2015 Swing Trading with Stochastic Oscillator and Candlestick Patterns Trading Setups Review
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This is the daily chart of SYSCO Corporation (SYY on NYSE). The bottom panel shows the StochasticOscillator.
1. Look at the last two points when the Stochastic was oversold. Compare the price levels. If themore recent oversold point is at a higher price, we are bullish.
2. With a bullish view, we looked for Morning Stars. This Morning Star did not occur with anoversold Stochastic reading. Thus, it did not fit our trading rules.
3. The second Morning Star had the support of the Stochastic Oscillator and fitted the bill. Wewent long as the Morning Star completed.
In this example, we managed to skip the losing pattern and take the profitable one with the help ofthe Stochastic Oscillator.
LOSING TRADE – INTC SHORT SWING
7/31/2015 Swing Trading with Stochastic Oscillator and Candlestick Patterns Trading Setups Review
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The chart above shows the daily price bars of Intel Corporation (INTC on NYSE).
1. Look at the last two points when the Stochastic was overbought. Compare the price levels. Ifthe more recent overbought point occurs at a lower price level, we are bearish bias.
2. We ignored this Evening Star pattern as the Stochastic Oscillator was not overbought.3. This second Evening Star pattern formed as the Stochastic Oscillator became overbought. Thus,
it was a valid bearish setup. However, this setup failed quickly as the market gapped up.
While we managed to filter out the first Evening Star with the Stochastic Oscillator, we could notavoid the second one. This short setup, despite its failure, was reasonable.
One minor factor that might have deterred us from going short was the price gap highlighted by thegreen box in the chart above. The market has a tendency to rest obvious gaps like this one. Hence, ifwe held this expectation, we would not have taken the short setup.
REVIEW – STOCHASTIC WITH CANDLESTICK PATTERNSCombining candlestick patterns with technical indicators is a sound approach. Here, we combinedan oscillator and a three-bar pattern to find pullback trades.
This trading strategy is not perfect and is certainly not profitable if traded mechanically. However, itoffers a solid starting point for both system and discretionary swing traders.
Both the Stochastic Oscillator and candlestick patterns are well-defined. Hence, they are easy tocode into market scanning software. For swing traders finding opportunities among hundreds of
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stocks, this is a huge advantage.
I looked at the Stochastic Oscillator and price action to decipher the trend to avoid adding indicators.You can certainly use other methods to track the market trend. (For e.g. market structure, movingaverage)
Since you like candlesticks, here’s more for you:
Candlesticks with Moving AverageCandlesticks with Pivot PointsCandlesticks with RSISteve Nison’s Japanese Candlestick Charting Techniques
Confused by complicated patterns? Pick up a simple and effective price patternto improve your trades.
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