In this article we'll explore a Forex Trading Strategy using the RSI and the Stochastic oscillator combined with two Exponential Moving Averages (EMA). While not generally complicated these indicators, when combined, put the odds of a profitable forex trade heavily in favor of the trader.
We know the RSI is a momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset. The RSI crosses over a 50% line indicating a positive or negative bias. A reading above 70 is reaching overbought; while a reading below 30 is approaching oversold. Standard setting for the RSI is 14.
The Stochastic oscillator is a familiar old friend to all technical traders. It is a technical momentum indicator that compares a security's closing price to its price range over a given time period. The oscillator's sensitivity to market movements can be reduced by adjusting the time period or by taking a moving average of the result. It has a reading of 0 to 100. A reading under 20 is considered oversold; while a reading over 80 is thought to be overbought. Standard setting for the Stochastics oscillator is 14,3,3.
Now, let's combine these two indicators with two Exponential Moving Averages (EMAs). An EMA differs from a Simple Moving Average in that greater weight is given to the more recent data when calculating the average and since is considered a more accurate, more timely indicator. When all these are pointing in the same direction, we have a set-up for a trade where the odds are heavily in the trader's favor.
This is a little tricky to explain without the benefit of graphics. If you're familiar with how these indicators work, it should be manageable.
The rules for entering a trade are:
1) the 5 EMA has to cross over the 10 EMA;
2) the RSI has to cross above or below the 50% line;
3) the Stochastics need to cross up or down as well, but not exceed the 20 or 80 levels.
All three need to take place, all at the same time and all pointing in the same direction. It's also a good idea to check the higher timeframes, H4 and D1, to see that you're trading in the direction of the overall trend.
When you have your indicators line up like this … it's a pretty good indication that you're safe entering the trade. You could stagger your take profit levels as some signal providers I've seen recommend. Take one-third at 10 pips, another third at 20 or 25 pips and let the final third run with a trailing stop loss.