STOCH Binary Options Trading Strategy

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60-minute Binary Options Strategy using the Stochastic Oscillator

With this strategy we will take advantage of extreme price conditions – overselling and overbuying a particular trading instrument. The only indicator in use here is the Slow Stochastic with its default settings (3, 3, 15, oversold at 20.00, overbought at 80.00). More detailed information about this oscillator is to be found here. The time frame is set to 15 minutes, while the expiry time is 60 minutes (a four-candle expiration time).

In order to make trading decisions, one needs to take into account the following:

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If he/she is to buy a Call option, one needs to look for oversold market conditions. The Slow Stochastic will provide such a signal by crossing the 20.00 level in a bottom up manner.

If he/she is to buy a Put option, one needs to look for overbought market conditions. The Slow Stochastic will provide such a signal by crossing the 80.00 level in a top-down manner.

What is particularly important to note here is that the Slow Stochastic (as well as any other oscillator) tends to provide the most reliable signals when the price of the asset is moving within a trading range. In trending environment the possibility of a number of false signals is significant. Therefore, one should use this strategy only after he/she has identified ranging market conditions.

On the 15-minute charts above the vertical lines mark where a call and a put entry should be made, while the triangles mark the option expiry.

Stochastic Oscillator

A large number of trading signals does not necessarily mean more profits in binary options trading. Some of the signals are false when the workout is made in a sideways range or it’s too short to make a decent profit. Stochastic Oscillator Strategy was developed to solve the issue of fake breakouts, filter the market noise, lower the number of trading signals and increase their efficiency.

Technical indicators based on measuring market waves – oscillators – became very popular as they show several layers of information needed for a binary options trader to make profitable trading decisions on a daily basis. It is well-known that financial markets always move like waves in terms of up- and down-swings, even during strong trends happen retracements or consolidations when CALL or PUT options buyers take a breather to rebalance the supply-demand ratio. Oscillators were created to measure those waves and reflect them in a visual representation so traders could make decisions at first glance on a price chart.

What is a Stochastic oscillator?

Stochastic was one of the first oscillators ever developed in the technical analysis. It has a simple mathematical formula comparing the relative momentum or strength of a trend to the price range between the lowest and highest prices within the given period. The oscillator also has overbought and oversold levels, the position of which in the indicator’s window can be adjusted depending on how frequently traders want to get signals. It consists of two lines ranging between 0 and 100. Binary options traders can apply an additional smoothing of the oscillator by enlarging the calculation period or by applying a moving average of the result.

Here is how the Stochastic Oscillator looks like on a price chart:

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Stochastic oscillator formula

The formula is as follows:

Stochastic %K = [ (Close – Low N) / (High N – Low N)] / 100,

%D = simple moving average of %K in 3 periods

Stochastic %K is the current value of the stochastic oscillator (blue line),

%D is – close is the most recent close price,

Low N – is the lowest price in N periods, typically 14 bars,

High N – is the highest price in N periods.

Stochastic oscillator settings

An important factor to adjust indicator’s sensitivity is to change the default parameters of the formula. Best stochastic oscillator settings can be selected depending on a personal trading strategy, the frequency of entries, a particular asset class and so on.

Default parameters in Stochastics are as follows:

  • %K period – 14 bars (hours or days, depending on the timeframe);
  • %D period – 3 bars;
  • Smoothing – 3 bars;
  • Overbought level – 80;
  • Oversold level – 20.

The main period influences the mathematical formula and determines how many periods should be taken for the calculation of the blue line. This is the key factor impacting the indicator’s sensitivity. If a trader enlarged the period, then the oscillator would get a more smoothed shape, and the number of bounces towards extreme values will be lower. Such a choice is suitable for long-term traders interested to catch strong price action, while short-term and insignificant fluctuations are ignored. When reducing the period, the indicator would start waving much more frequently, sending more trading signals. This selection might be attractive for short-term traders with many deals to open in the same period. Lowering the oscillator’s period would lead to a larger number of false signals though.

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Other settings are not so important and it would be better to leave them as default. %D period points to how many periods are used for the simple moving average of the %K line. Too many periods would cut peaks and bottoms of the value, while a lower period would not reach the necessary effect of the moving average. The widest range of this parameter is from 3 to 9 bars. Smoothing period is also good enough for any applications. Shifting overbought and oversold levels would enlarge or lower the overall number of trading signals. Again, default settings reflect the market conditions in the best way.

How to use stochastic oscillator?

The main advantage of a stochastics indicator is that it shows the current momentum. In other words, the oscillator measures the strength of the recent price action compared to the previous action in the chosen period. From a trading point of view, analysts find periods when stochastic lines are coming out of the oversold (bullish reversal) and overbought (bearish conditions) levels. This means that the bears or the bulls start losing power to move prices in the previous direction and the trend starts in the opposite direction. One more important event happening at that time is that both lines of the oscillator cross each other, preferably in the oversold or overbought zone. The crossover means that recent prices are changing faster than the moving average of the Stochastic %K value, shifting the technical sentiment.

This is a perfect reversal signal:

Stochastics oscillator have a disadvantage, like any other sensitive indicators based on measuring waves. The problem is that a reversal trading signal does not necessarily mean a complete trend reversal. If a short-term rebound or a sideways consolidation happens after an uptrend peaked, for example, the lines of the indicator could start sliding but the following price action is insignificant. Rates could just hover in a tight range or a short-term plunge is charted, but the trading does not bring the wished result in terms of a sustainable counter-trend. This is why a second layer is added to the equation.

What is slow and fast stochastic oscillator

The main idea is to combine two oscillators with different periods. The first indicator is the fast stochastic oscillator with periods 8, 5, 3. The main goal for such a sensitive indicator is to provide preliminary or initial trading signals. Binary options do not take the trade immediately after the fast stochastic offers an opportunity but start monitoring an additional instrument. The second indicator in the combination is the slow stochastic oscillator with settings 17, 7, 3. It works as a confirmation tool after the fast indicator provides a preliminary signal. As a result, traders do not start entering the market too early, the market conditions get an additional smoothing, the unnecessary noise is cut out of the equation and the overall effectiveness of the trading system increases.

Examples of using

Buying PUT options for USD/CAD after an uptrend reversed

The daily chart below shows the USD/CAD currency pair in a long-term uptrend. An initial reversal signal came in from the fast oscillator as its lines performed the bearish crossover in overbought territory. However, the uptrend continued for two more days before the bears stepped in with heavy-volume demand for PUT options. The slow stochastic signalled the beginning of a new downtrend when its lines went off the overbought zone. As the price chart shows, the trading cycle of buying PUT options was profitable until an opposite signal occurred.

Buying CALL options for USD/JPY after an intraday rebound

The four-hourly chart below points to a strong reversal signal after USD/JPY bottomed out on October 31, 2020. The fast stochastic had a preliminary signal, showing a bullish crossover in the oversold zone. However, the confirmation came only two candles after that (8 hours). The trading cycle of buying CALL options was lucrative as 81.25% of the deals were in the money. The cycle was stopped when both oscillators had an opposite signal, pointing to a bearish reversal.

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Stochastics have been used as a predictive stock indicator since the late 1950’s and are applied to a broad range of trading today including binary options trading. It is a trade analysis that is made based on a ‘stochastic oscillator’, which is simply technical analysis that uses a momentum indicator by comparing a securities asset’s current closing price with its historical price over a set period of time. It is an oscillation type indicator.

Stochastic oscillators tend to have reduced market sensitivity and area more accurate means of determining potential asset price movement when established using an adjustment of a time period or when they are calculated by using a moving average to determine them.

Contrary to popular belief, a stochastic indicator does not follow price or volume. It is an analysis tool that follows the momentum of price. Things such as bearish and bullish divergences can then be used to predict trend reversals on which to make profitable trades.

When it comes to analyzing potential binary options trades the stochastic indicator generally has a set value in the up side of 80 and a set value on the down side of 20. The indicator consists of two lines; one represents what is often referred to as the fast stochastic and the other line is often referred to as the slow stochastic. It is the intersection of these two lines that are of particular interest to a trader.

These intersections or crossing of the lines are then analyzed to see if the asset that is being tracked is currently in an oversold or undersold range. Based on which of these the asset is in, it is then considered a good time to place a put or call option on that asset.

One of the key considerations in making a profitable trade is the time frame that the indicator is plotted for. This holds true because more often than not the successful trade largely depends on determining an accurate expiration date. As a result of this, it is not logical to use a 5 minute chart to make a determination and then place your option on a daily or weekly expiration date. So it is extremely important to take note of this and follow this general rule on a consistent basis.

As you can see, a stochastic indicator can be very useful when it comes to making trades which are based on identifying a trend reversal.

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