Next, we will explain a technical trading system for Forex and other markets which uses two well-known technical indicators, the MACD and the stochastic oscillator to generate market entry signals. Specifically, it uses the MACD histogram and the stochastic oscillator to confirm market movements, as both are indicators of price momentum.
As it is a technical trading system, it has mechanical and relatively simple entry and exit rules, which only require the trader to be disciplined and apply these rules to the letter. However, it should be noted that technical indicators usually present unreliable signals when markets are dominated by strong fundamentals. Therefore, it is recommended to be aware of important economic indicators and fundamental news as they can cause a substantial increase in volatility.
As always, it is recommended to test this system with a demo account before using it for real money trading.
Configuration and rules of the trading system
- Recommended markets: This trading methodology was initially designed to operate in the Forex market, but it can also be used in other markets, such as indices or cryptocurrencies.
- Recommended time frames : This system can be used in the 4 hour (H4) and daily (D1) time frames.
- Recommended market periods: The system can be used in all market periods, although it must be taken into account that each market session has its own characteristics in terms of volatility and strength of movements
- System indicators : The technical indicators used by this system are the following:
- 1 simple moving average (SMA) of 10 periods.
- 1 stochastic oscillator with the following settings: (10, 6, 3). It is recommended to place a line on levels 20 and 80 to be used later.
- 1 MACD histogram with standard settings (12, 26, 9).
This system does not make use of any modified indicator for MT4. However, we include a template that allows you to use the system on any price chart on this trading platform by applying the above settings on all indicators.
-System template with stochastic oscillator and MACD histogram
Rules of the trading system
The rules for opening and closing positions in this strategy are as follows:
Opening of purchase operations
We open a buy position when the following signals occur:
- One candle closes above the 10 SMA. This is an initial sign of the possible start of a bullish move in the market.
- The MACD histogram crosses the zero line from the bottom up.
- The lines of the stochastic oscillator make a bullish crossover and begin to rise, preferably above the 20 level (oversold zone in the stochastic oscillator).
- Position opening: When these conditions are met, we must wait for the next candle to open to open the buy position, since at the signal candle at some point the price could fall and close below the 10 SMA. it is better to wait until this candle closes.
Opening of sales operations
We open a sell position when the following signals occur:
- One candle closes below the 10 SMA. This is an initial sign of the possible beginning of a bearish movement in the market.
- The MACD histogram crosses the zero line from top to bottom.
- The lines of the stochastic oscillator make a bearish crossover and begin to fall, preferably below the 80 level (overbought zone in the stochastic oscillator).
- Position opening: When these conditions are met, we must wait for the next candle to open to open the sell position, since at the signal candle at some point the price could rise and close above the 10 SMA. it is better to wait until this candle closes.
Stop loss and take profit
The placement of the stop loss and take profit point depends on the risk management and money management practices of the trader. For the stop loss we can choose one of the following options:
- The stop loss can be placed below (above) the low (high) of the most recent swing. This is the option that places the stop loss furthest from the entry point, which carries the most risk, but at the same time gives the trade the most margin to develop.
- The stop loss can be placed below (above) the low (high) of the candle prior to the candle that closes above the 10 SMA.
- A more aggressive option is to place the stop loss below (above) the minimum (maximum) of the signal candle (the candle that forms before the opening candle of the position).
For profit taking , it is recommended to use a Risk: Profits ratio of 1: 2 or even 1: 3, in such a way that in the winning operations the trader obtains a profit of at least twice the amount risked in the operation . For example, on a trade that has a stop loss of 45 pips, a take profit target can be placed at 90 pips or 135 pips from the entry point.
IF we trade 0.1 lots, this means a profit / loss of 1 per pip, so we could lose $ 45 on this trade. If our account has $ 4500, then this represents a risk of 1% of the account.
According to the theory, it is recommended to risk a maximum of 2% or 3% in each operation. If we trade 0.3 lots, which implies a profit / loss of $ 3 per pip, then we are risking $ 135 on the trade, which represents 3% of the total capital of the account.
In the image above we have a 4-hour chart of the GBP / CHF currency pair, which shows a buy operation carried out with this system. Next we are going to analyze the operation step by step explaining its signals in the numbered candles in the image:
- At candle 1, the price begins to rise but is still below the 10 SMA, in addition the MACD histogram also begins to rise but is below the 0 level, and the stochastic oscillator lines are just beginning to make a bullish crossover. .
- At candle 2, the price crosses and closes above the 10 SMA, while the MACD histogram remains below the 0 line and the stochastic oscillator lines cross to the upside and begin to rise. We still do not have a buy signal as only 2 of the 3 conditions are met.
- At candle 3, all the conditions for opening a buy position are met. Now the MACD histogram is above line 0.
- The buy position is opened at the opening of candle 4. Entry occurs at a price of 1.47210.
- The stop loss can be placed according to any of the options explained above. In this case, we put it below the low of the candle formed before the signal candle, which gives us a stop loss of 47 pips.
- The profit-taking target is placed at a distance equal to twice the stop loss, that is, 94 pips.
In this example, shortly after we open the buy trade, the price begins to rise and eventually reaches the profit target. However, the price doesn’t go much higher before making a strong bearish retracement, so it was nice to have used a fixed profit target.