# Stochastic Trend Following Strategy

Stochastics is one of my top indicators. It is useful for making several different types of technical analysis, the one I am going to discuss today is trend following signals.  Trend following signals are one of the best types of signals that this indicator gives and one that can be highly profitable for binary traders.  I prefer to trade trend following signals because they are more reliable. This may sound redundant as most trading educators will tell you that “the trend is your friend and you should trade with your friend”. Well, it is and it is true. The power of the trend is without equal in trading.

## What Is Stochastic

Stochastic is a unique indicator in that it assumes that the shorter term movements of an asset are random and cannot be predicted.  It is based on random walk theory and Brownian motion. Whereas the short term fluctuations are random, over time those random movements can be plotted in a way that predicts overall direction. It’s like this; Imagine a man walking a dog, the dog may pull the man side to side as it moves on the leash but the man controls the over all direction the two are moving in. In this analogy the dog is the short term random day to day movement of the market where the man represents the longer term trend. No matter how strong the day to day gyrations of the market (the dog) pull against the trend (the man), the trend still leads the market higher.

• Stochastic oscillator uses two lines, %K and %D. The %K line is calculated and then smoothed with a moving average to produce the %D line. Signals can be taken in a variety of ways including crossovers, convergences and divergences. Click here for more on using stochastic to trade binary options.

## What Is The Trend?

The trend is the general direction of the market. It will either be up, down or sideways.  Sometimes an asset will trend strongly, that is it will visibly move higher on your charts. Sometimes it will trend weakly, becoming visible as different technical analysis techniques are applied. I will describe two methods of determining trend that can be used with this strategy. First will be the visual method, for the second I will tell you how to use stochastic and time frame to determine trend.

Visual Trend Determination – Visual trend determination can be done with the naked eye. Two things that make it easier is experience and a strong trend. Otherwise you will need to use trend lines. Trend lines connect consecutive peaks and troughs on an asset chart. A series of higher peaks and troughs equals an uptrend, a series of lower peaks and troughs a downtrend.  If the peaks and troughs do not trend higher or lower then the trend is said to be sideways or range bound.  Stochastic trend following signals work better in an up or downtrend but can also be used in a sideways market.

Using Stochastic To Find Trend – Stochastic can be used to find or to confirm trends. Stochastic confirms a trend when it is making higher peaks along with an asset that is making higher peaks, or lower peaks as the case may be.  If stochastic is confirming a trend you can take a signal whenever stochastic is pointing in the direction of the trend. This is what I mean; if you have a visual up trend and stochastic is confirming it you can take a signal whenever stochastic makes a new trough and then points up.

• A series of higher peaks and troughs, or lower peaks and troughs, indicates trend the same as they would if presented on the price chart itself. Notice on the right hand chart below how the %D line makes a series of higher troughs coincident with the asset.

Using stochastic to find trend.

Using Time Frames For Trend – You can also use different time frames to determine trends with stochastic.  To do this you will need to use two different time frame charts, I like to use the weekly/daily or daily/hourly combination depending on the asset. Weekly/daily works well with stocks and indices while I prefer the shorter time frame for currency and commodities. This is how it works; stochastic on the longer term chart sets trend, stochastic on the shorter term chart gives the signal. If, on the weekly chart, stochastic is pointing up then you would trade bullish signals on the daily charts. Or if using the daily/hourly combo the stochastic on the daily would set trend while signals would come from the hourly chart.

• Match stochastic in different time frames to determine trend. If stochastic is pointing or trending up in a longer time frame then bullish stochastic signals can be taken in a shorter time frame. Look at the chart above. On the left hand side, weekly data, the asset formed a bottom between November-February with a bullish stochastic crossover setting the trend. On the right hand side, daily data, bullish signals are taken for short term trades.

## Stochastic Trend Following Signals

Weak Signal/Strong Signal – This technique will give off at least three signals that I regularly follow. The weak signal, the strong signal and the continuation signal. The weak signal is always the first one you will see. It takes a lot of practice to be able to capture this signal and profit consistently but the good news is, it is almost always followed by the strong signal. The weak signal is when the indicator first changes direction to return to the underlying trend.  This signal usually takes longer to develop into profits so I use longer expiry with this one. A signal on the daily charts may take 1-3 weeks to move into the money whereas a signal on the hourly charts may take a few days or a week. For the daily signal, use a one month expiry, for the hourly use one week.

The Strong Signal – The strong signal comes after the weak signal, in fact, there is no strong signal without the weak signal. This is good news because if you did not catch the weak signal you can still get in with the strong one. The strong signal occurs after the market moves on the weak signal, retests support and then moves higher again. This causes a comparable dip/retest on the indicator as shown in the picture below.  Strong signals usually develop into profitability much faster so I use a much shorter expiry. For signals on the daily charts one week is usually perfect while on the hourly charts end of day or end of tomorrow works very well.

• The strong signal always happens after the weak signal. The strong signal confirms support and is usually accompanied by a coincident signal in the asset. Look at the chart above. At point 1 the weak signal is given. At point 2 the strong signal is given, notice how at point 2A the asset is making a similar confirmation of support and then moves higher.

The Continuation Signal – Once the asset is trending on the strong signal it is time to look out for possible continuation signals. This will be a dip or ripple in the stochastic indicator similar to the strong signal but occurring after the move has begun.  It could also occur after a near term pullback. Look at the chart above.  After the strong signal has fired the asset moves higher until it reaches over bought status. The asset keeps trending higher but the %D crosses below and then back above the %K line forming a continuation signal.

• Once the strong signal has been given and the asset is moving higher any time that the %D dips or crosses below the %K line and then points back up can be considered a continuation signal. If both lines are pointing in the same direction (up in an uptrend, down in a downtrend) the signal is stronger than if not. Look at the chart above. At point 3 the asset has dipped below the %D and then crossed back above creating a continuation signal.

## Support and Resistance With Stochastic

Support and resistance are great additions to this strategy. For one, if your signal is developing while the asset is testing or confirming either support or resistance it is a much strong signal than if not. For another, if your signal fires and there is a resistance level close by it may adversely affect your trade. Knowing where these areas are in relation to the asset price and stochastic is a really good way to weed out false signals and potentially bad trades.

• I use support and resistance with stochastic to create strong signals. I draw my own lines and also use the Fibonacci Tool available with most charting packages. If my stochastic signal forms and confirms a support or resistance it is a stronger signal than if it forms on its own. Likewise, it takes more than an asset to reach or even bounce off a support or resistance line to create a strong signal.  If you look back at all of the charts I have presented here today you will notice that each of the strong signals was confirming support of some kind. Support could be a moving average, support line, trend line, Fibonacci, Bollinger Band or many many other forms of technical analysis.

I have another article about using support and resistance in trading. It is a great addition to this technique and one I highly recommend.

# Choosing Binary Options Expiry

This post is a follow up to one I recently wrote about choosing binary options expiry. The previous posting was focused on measuring your charts and logging the information in a table so that you would know the average movement of a chosen asset for a given time frame. If you don’t know what I am talking about I suggest you read that post, there will be a link later. This post ties into that one but focuses more on stronger signals and weaker signals. For example, with a strong signal I may choose an option with expiry towards the short end of the expected time it would take for the option to move into the money. With a weaker signal I may choose to use an expiry at the longer end of the expected time frame.

## Statistical Analysis And Your Charts

Example of chart data that can affect expiry choices

This is what I mean. In the previous article I described a method of measuring the length and magnitude of rallies and declines. These measurements are entered into a table and an average is given. This average can be used to help determine appropriate expiry’s. What I did not hit on the last time were the other important statistical points that can be gleaned from the data. For one, the median. The average and the median are not the same thing, one or both could be skewed. For another are the extremes and that is what this post is about. The extremes tell you what to expect when the unexpected happens. Let’s think about this from the perspective of the trade and signal. There is a sample amount of signals, some extreme and some average. The strong signals will correlate to the short extreme and the weak signals will most likely correlate to the long extreme in terms of the average amount of time it takes for a signal to produce a winning trade.

What constitutes a strong and a weak signal will depend on your trading system. I use a variety of different indicators and can get strong and weak signals in a number of ways. For this example I want to use a trade I made on Communitraders as part of my weekly column, Tips From The Geek. The trade is on gold. At the time the tip was made I was getting bearish signals but they were weak. I couldn’t discount them, and since the longer term trend was down I wasn’t about to risk a bullish trade, so I had to act. I was sure my analysis was right but was unsure of the time frame, a perfect time to look at my tables and see just how long it might take for a weak signal to develop. Based on my data and analysis I chose an expiry of one month.

In between the time that I opened the trade and closed it the price of gold fluctuated wildly. Economic data, Quantitative Easing and global recovery were playing havoc with expectations and demand. At one time this trade moved more than \$60 out of the money. I had written it off on more than one occasion. Losses are part of the game so I wasn’t too upset. However, I wrote it off too soon. My analysis had been correct. Near term noise had a negative impact on my analysis but the longer term trend held true and it eventually did close in the money.

This chart shows entry and expiry.

## Choosing The Right Expiry Can Make All The Difference

Let’s take a quick look at the charts. At first glance you would think that playing a call may have been better at this time but my analysis was bearish. I was just uncertain of time frame because of the weakness of the signal. Based on my tables I knew I could expect it to take 4 weeks or more for this kind of signal to develop. I choose to use a one month expiry and managed to squeak out a profit. Just a week later the price of gold dropped again, breaking a major support and confirming my long term analysis. I could have trade calls in the interim but with bearish technicals I judged it to be a bad idea. By using my data tables  I was able to pick an expiry appropriate to the signal and was able to make a profitable trade if barely. Trusting your analysis can sometimes be the hardest thing to do, I readily admit being worried this trade was going to lose. Choosing the right expiry can be the difference between a winning trade and a losing one.

# How To Choose The Right Binary Options Expiry

Choosing the right expiry, or amount of time until your binary option expires, is perhaps one of the most difficult concepts to master. Too many times have I sat and watched a trade move in the money, and then out of the money, and then in the money, and then out of the money just before expiry only to move back above my strike price after my options expired worthless. This is one of the most frustrating parts of trading and one of the reasons why I don’t watch open trades. I usually keep between 5 and 12 trades open at any one time. My goal is to open 5 new trades per week making small investments with each trade. Sometimes my trades have an expiration of 3 days or less, sometimes a week and sometimes a month or longer. There are three things to try to keep in mind when choosing expiration; what kind of signal was it, what time frame was the chart and what duration to expect for the movement.

This binary trade was in the money several times before expiring out of the money.

Charting Basics

One of the very first things I ever learned to do was to “measure” my charts. I learned to measure each and every rally, in each and every time frame that I use and I have found that this technique is great for social trading binary options as well. Measure each and every bear market, being sure to measure the length of each leg as well. I was also taught to measure the height and lengths of triangle patterns, consolidations and reversals. I taught to do this so that I would know what the average number of legs in a primary bull is. So that I would know how long to expect a bear market in the secondary trend last and so that I would know how far on average a break-out of an ascending triangle would be. This may sound time consuming and maybe even a little confusing but it’s really very easy, especially with computers. Imagine doing all that math without a spreadsheet!

1. I started with 5 year charts of weekly data- measure the length and height of any bull and bear markets you see. I measure from the highest intra-day high to the lowest intra-day low.  Count the number of legs in each rally and in each bear market, measure each of them. If there are any trading ranges, consolidations or significant patterns present measure them as well. Enter each figure into a table in consecutive order, have the math program perform averages for you so that you know the stats for each category over the long term.
2. Next I moved down to one year charts of daily prices. I always use candlestick charts because they make it easy to see the markets. I measure all the rallies and bear markets in this time frame as well. I enter all this data into another table I have made for this data. Now I know what the average movements are over the short term.
3. I also trade near term positions using charts of hourly/30 data depending on the asset. It is up to you to choose which to use. Some assets don’t move as fast as others so they need the hourly in my opinion. Make the same measurements as on the other charts and log them into a table. Now you have the average data over the near term.
4. Now you have to maintain your data. Each time the market completes a movement you need to update your tables. You will spend the most time updating the near term tables and the least time updating the long term tables.

I know from my own tracking data of asset XYZ that I can expect a long term primary trend to last for 3-5 years. Within that primary trend I can expect 3-5 bull markets with a corresponding number of corrections. Each bull market will last between 6 months and a year or so before correcting with each correction lasting from 1 to 3 months, give or take. When I move down to charts of daily prices I know that short term up trends can last up to a year or more with 3-5 bull markets and corrections along the way. Each of the bull markets  in a short term up trend usually last about 2 months but can vary depending on conditions. Each correction of a short term trend usually lasts for 2-3 weeks but every up-legs there will be a major correction up to 5% or more that will coincide with an expected correction on the long term weekly charts. I think by now you get the idea of just how much information you can get from measuring your charts in this manner. Now, what do you do with the information.

How To Choose Binary Options Expiry

Choosing expiry is much easier when you have in depth knowledge of how far and how fast an assets movement will be. The trick is using the information gleaned from the tables you create to help you pick just the right entry. This is how it works. First identify/quantify the type of signal you are trading on. Is it a signal from a long term weekly chart or from a short term daily chart or from an even shorter term chart like hourly, 30 minute or 60 second. Is the signal a bull signal or a bear signal? Is it the weak first signal or the stronger second signal (most of my techniques will fire a first weak signal and then a stronger second signal)? Once you answer these questions you can move to your tables. Choose the data set that matches the signal you are taking, from there you determine an appropriate expiration.

For example; let’s assume we are trading a buy signal on the daily charts of asset XYZ. The signal is supported by a corresponding signal on the longer term charts so we are fairly certain of the trade.  Indications are for a new up leg in a short term bull market that is part of a longer term bullish movement. Lets also assume that asset XYZ also performs in a similar fashion to what I described above . So, since we are expecting asset XYZ to enter a new leg of a short term bullish up trend, and since we my tables tell me that this type of signal usually results in a two month rally followed by a one month decline I can set my expiration accordingly. I will want to set the expiration far enough out for the asset to rally and move into the money but not too far out. In this case at least a week in order for the market move higher but no more than two months. If I think the signal is strong one week is plenty, if it is a weaker signal one month does better.

• Long term signal (weekly charts) – In my data long term signals take 2-4 weeks to move into the money and then continue to rally for 6-12 months. In this case I usually choose to trade monthly positions for this asset. You will need to create your own tables in order to predict long term movements for your chosen asset.
• Short term signal (daily charts) – In my data short term signals take 3-5 days to develop and begin to move. Bear signals are usually much quicker than bull signals. Once the signal begins to move into the money it could keep trending higher for 2 months or more before correcting.
• Near term signals (hourly charts) – In my data a strong signal on an hourly chart can last for 10-15 days. I only trade near term signals when they correspond to the underlying trend.

My data tables help me choose the right binary options expiry.

The same applies to longer and shorter term charts. Simply follow the guidelines set by your tables. Use the tables along side your trading diary and log books to help  fine tune your system. I use several types of indicators and analysis in my trading so whenever I take a signal I always write down what kind it is so I can go back and see which ones work better than others. This (keeping a log)  is much harder to do when you are trading a lot, especially with 60 second and other super short term expirys. You can still use my method of choosing expiry. When I want to day trade or see a good signal on a one hour chart I have data for that time frame too.

• Here are some tips on what to measure and track. 1) data for weekly, daily and hourly/30 minute charts  2) what the signal is 3) how long until moves into the money 4) how many rallies, declines in a trend 5) how long until correction/reversal 6) how long are corrections/reversals 7) average each data so that at any given time you know the expected length and duration of any movement in your chosen asset.
• You may also want to take note of any catalyst that occur alongside your signals. These could include news announcements, earnings, inventory numbers or economic data and many other market moving events.