"DAILY 3" STO CHASTIC POSITION TRADING SYSTEM

By Alan Benefield

Reviewed & Recommended By

Indrajit Mukherjee

http://www.stockmaniacs.net

PART I

My system is designed to be used by someone who works a day job and can not watch the charts during the main sessions. It does not take months to learn this system and I feel that anyone can learn this in a few hours. We will be spending most of our time looking at the daily and weekly charts. You need to remember 3 key pictures. Two are about fishing, fish and fish net. The third one is a wall or a dam. The thicker the wall, the harder it is to knock down. I know this doesn’t make any sense yet, but it will, as you learn more.

The Daily 3 Stochastic System is a quick visual method of finding good long term trading setups at the first glance of the charts. I use a system of colors on price action as well as other indicators. We will be using 15 EMAs (Exponential Moving Averages) with 5 indicators color-coded on the charts. This sounds like a lot of indicators to worry about, but you will see that I have made this extremely simple to apply them all. We only use 3 when first looking for trading opportunities and then 2 more for confirmation. The two confirming indicators are optional. The system can be used with only the main indicators but I suggest to use them all. All EMAs are used to show resistance or support to price action and overall price trend.

In this first article, we will be looking at the EMAs used in this system. Exponential Moving Averages: Applied to Close of the price 200 EMA black thick solid line 144 EMA black thin long dash 89 EMA black thin dotted line Guppy EMAs (GMMA): Applied to Close of the price 6 fast blue Thin Solid EMA lines 3, 5, 8, 10, 12, 15. 6 slow red Thin Solid EMA lines 30, 35, 40, 45, 50 and 60. I like to plot these in another price window by themselves to expand them over the whole chart. Daryl Guppy is the inventor of this system using 12 Exponential Moving Averages called Guppy Multiple Moving Averages (GMMA). Six slow EMAs red, with six fast EMAs blue. We can think of the red slow EMAs as the fish or water flow. This system uses EMAs to show strength of the trend as well as resistance to price action. Same applies to the GMMA. More about Daryl Guppy can be found at this link: http://www.guppytraders.com/

Illustration I

1. Shows the red GMMAs spreading apart with good angle and separation. This shows that it’s a strong trend - fast moving water in this river, or think of it as a group of fish swimming in the same direction. 2. Shows the GMMAs coming together or converging. This shows a weak trend or a new trend starting. When red EMAs are close together, it’s easy for price action to cross over them. 3. Shows the fast blue GMMAs bouncing off the now spreading red slow GMMAs. This would be a good sell signal from just looking at the GMMAs on this chart. This would be confirmed by our Stochastic going overbought. When the blue EMAs punches in all the way through the red EMAs, it is an early warning that the trend may be ending. Look at how the lines crossed, I call this a fish net. Now let’s go back and look again at that first chart.

Illustration 2

Notice how Stochastic went to the top - that would be overbought and a good place to enter into this downtrend. The blue EMAs bounced off red EMAs like hitting a wall. When you see the red EMAs spreading apart, then use Stochastic oscillator 8, 3, 3 to enter in a downtrend. Now let’s look at the other EMAs used with this system. 200 EMA - the solid black line 144 EMA – the long dash black line 89 EMA – the dotted black line

Illustration 3

Look how price action behaves when it hits the EMAs on this chart. On the left side we see a step up action before the 200 EMA finally sends the price back down. Now we add the GMMAs with the rest of the EMAs to get the next chart.

Illustration 4

Above is a quick example of a trend buy using the Stochastic oscillator in a good uptrend, shown at the far left of the chart. We will cover this in more detail in the next article. 1. Shows candles or price action being resistant to the 89 EMA. Look closely and you will see that it hit the 89 EMA three times before it moved down to the 144 EMA. 2. Shows price action hitting the 144 EMA before moving down to the 200 EMA. 3. This shows the 200 EMA ( Great Wall of China) stopping the downward price action attack dead in its tracks! Think of the 89, 144 and 200 EMAs as walls that must be knocked down, so that price action can move on. When the 89 EMA is above the 200 EMA than this is showing an upward trending price action. With the GMMAs the more separation – spreading apart with good angle and separation you have, the stronger the trend is.

STOCHASTIC OSCILLATOR PART II

The Stochastic oscillator was developed by Dr. George Lane to help track market momentum. While most indicators use the close of the price action, the Stochastic oscillator tracks the high and low over x number of days. If you use just the close, then you basically have another moving average. By using the extremes of price, you get a leading signal ahead of average based indicators.

Stochastic settings are 8, 3, 3 Nbr periods 8, %K3, %D3. Up movement blue for both lines and down movement red for both lines. Make them thick so it’s easy to see. Horizontal Line at 50 mark dotted line.

Illustration I

Trading Signals When Stochastic is all the way to the top at 100 level - it’s overbought. Go short when it

starts to hook back down heading for oversold 0 level. The opposite is true also, when it’s in the oversold area at or around 0 - then look for it to hook “fish hook” back up heading for overbought. The shape of a Stochastic bottom gives some indication of the ensuing rally. A narrow bottom that is not very deep indicates that bears are weak and that the following rally should be strong. A broad deep bottom signals that bears are strong and that the rally should be weak.

The same applies to Stochastic tops. Narrow tops indicate that the bulls are weak and that the correction is likely to be severe. High wide tops indicate that bulls are strong and the correction is likely to be weak.

What timeframe to use with Stochastic The buy and sell signals work best on the higher time frame charts – the daily and 4 hour charts. Here is an example of how Stochastic becomes crazy when the same time is shown on the 4 hour and then 1 hour chart.

Illustration 2

On this 4 hour chart above, the circled area clearly shows a good signal.

Illustration 3

Now look what happens when we go down to the 1 hour chart. Looks like something broke on the Stochastic oscillator. However, the extra candles make for a good MACD buy signal. It’s a good example of using the Stochastic oscillator 8, 3, 3 to buy the dips in a strong uptrend.

Illustration 4

On the chart above we see that the red GMMAs are showing good angle and separation. We also see that the blue and red GMMAs are riding above the 89, 144 and 200 EMAs - this shows a long term uptrend. Also note that the 89 EMA is above the 144 EMA, which is above the 200 EMA. This again confirms a long term uptrend and forms walls of resistance to support price action. We have 3 Stochastic oscillator buy signals shown on the chart above. I call these “Trending Market Stochastic Dip Buy Signals”. Each black circle in the Stochastic oscillator shows oversold and a good place to hop into this uptrend or “jump in the boat on the river”. Look how the blue GMMAs together with price action dive into the red GMMAs and fail to penetrate past them. If the GMMAs ever get that far, they still have the 89, 144 and the 200 EMAs waiting for them. Remember, the trend is the flow of the river and we are jumping in at the best time, in order to ride the trend.

STOCHASTIC MOMENTUM INDEX PART III

In this article, we will cover the last indicator from the Daily 3 Stochastic System, the Stochastic Momentum Index (SMI), which is a smoother version of George Lane’s original Stochastic oscillator. This indicator was developed by William Blau and was first introduced in the magazine ‘Technical Analysis of Stocks & Commodities’ in January 1993. The formula for Stochastic Momentum Index makes for a much smoother oscillator or less erratic then the same period Stochastic oscillator. In order to smooth out George Lane’s Stochastic oscillator, most people would stretch the period say from 5, 3, 3 to 10, 3, 3. So the Stochastic Momentum Index is a naturally smoother indicator at a quicker setting then the Stochastic oscillator.

Illustration I

The Green/Red SMI is the 10, 3, 5, 3 for the daily chart. The Black/Baby Blue SMI is the 50, 15, 5, 3 setting that reflects the weekly chart.

Also note the dotted horizontal lines on the SMI indicator, this is the +60 and the -60, this is the line of death or the extreme overbought or oversold levels! You do not want to enter any trade if the 10, 3, 5, 3 SMI is at that level, due to risk of price reversal. Below are the SMI settings used in this system. Please note that this indicator is hard to find and you will have to see if it’s available on your charts. It’s available on the IT Finance charts. Stochastic Momentum Index (SMI) 10, 3, 5, 3 Make SMI 1 color up green and color down red, #3 thickness solid line. Make Signal 1 invisible. Signal method simple and apply to close. Add line at +60 and -60 a dotted line. Stochastic Momentum Index (SMI) 50, 15, 5, 3 Plot this on the same window as the 10, 3, 5, 3 above. Make SMI color up green blue and color down black, #2 thickness solid line. Make Signal #2 invisible. Signal method simple and apply to close. Trading Signals

Illustration 2

1. Sell signal when the weekly SMI goes black and the daily SMI goes Red and is not at or below the - 60 extreme over sold dotted line. Price action is not going to run into red GMMAs, or the 89, 144, or 200 EMAs. Here we enter when a candle closes below all the EMAs. Exit or profit taking on this trade would be when the daily SMI turns green. 2. Buy signal when the weekly SMI goes baby blue and the daily SMI goes green and is not at or above the +60 extreme over bought dotted line. Price action is not going to run into walls also known as red GMMAs or the 89, 144, or 200 EMAs. Exit or profit taking on this trade would be when the daily SMI turns red. 3. Again, another buy signal that is the same as above. In this case the weekly SMI is above the +60 line. However the daily SMI is below and moving up so it’s a good buy signal with a tighter stop. Using the IT Finance Charts, you can plot a mini version of the weekly SMI chart on top of the daily chart instead of plotting the 50, 15, 5, 3 in the same window. This gives a smoother weekly SMI signal to work with.

Illustration 3

Here is another chart with the weekly chart SMI fitted on the daily chart. This is the same signal line as the black/baby blue line on the daily chart, but it’s more of a distinct signal

in the little window. I like to have both up to get the best weekly sentiment on the overall trend before our EMAs tell us.

This is a buy because SMI daily is green and the SMI weekly is green or baby blue. Price action is moving away from all EMAs. In the next article, I will show you how to set up your charts and to apply two more optional confirming indicators.

DAILY 3 STOCHASTIC SYSTEM SETUP

PART IV

I use two monitors and the chart below is a set up I use for all 20 currency pairs. I have 5 lots called “Daily Guppy Master 1 – 5”. These are saved so I only need to click on them to pull each lot up. You can visit IT Finance site at http://www.cbfx.com/charts/chartsdemo.htm and download their chart manual to learn how to save templates or lots.

Illustration I

It takes many hours to set up these charts, but you will save yourself time later when you are trading.

RUNDOWN OF THE DAILY CHARTS

Illustration 2

Also I have what I call master charts for each of the 20 currency pairs. On these I have the 4 hour, daily, and weekly charts. I also plot the optional confirming indicators RSI and MACD with Stochastic oscillator, Stochastic Momentum Index and the GMMA window. In case you ever want to try day trading, I suggest setting up the 5 minute, 15 minute and 1 hour charts.

THIS IS WHAT MY MASTER CHARTS LOOK LIKE

Illustration 3

Here I plot 3 charts on one screen, the 4 hour chart, daily chart and weekly chart. You can also see all 5 indicators plotted with the two optional confirming indicators compressed down. Stochastic Oscillator (STO) Relative Strength Index (RSI) {compressed down} Moving Average Convergence Divergence (MACD) {compressed down} Stochastic Momentum Index (SMI) Guppy Multiple Moving Average (GMMA) {compressed down} Optional confirming indicators that I use on the master charts are listed below. I have found that you may also confirm the buys and sells by using the Relative Strength Index (RSI) and MACD Moving Average Convergence/Divergence. Relative Strength Index (RSI) I only use this indicator for signal confirmation to buy or sell. RSI 14 set to green going up and red going down, make line very thick so it’s easy to see. Horizontal line at 50 mark dotted line.

Signal Confirmation : RSI above 50% green is a good buy and RSI below 50% line and red is a good sell.

Illustration 4

MACD Moving Average Convergence/Divergence I do not look at MACD to make trades, but I will check it to confirm buy and sell signals. Settings are 12, 26, 9 short term MA 12, Long term MA 26, Signal Nbr periods 9. Make Signal line red solid line #3 and MACD line blue solid thickness # 3. Set MACD histogram to light green going up and orange going down. Signal Confirmation : When MACD blue is above Signal Line red and showing good angle and separation, then it’s a good buy. When the Signal Line red is above the MACD line blue and showing good angle and separation then it’s a good sell.

Illustration 5

I plot these on the daily chart to confirm the Stochastic Momentum Index (SMI) buy or sell signals.

Illustration 6

I plot those other indicators on the master charts compressed down. In the next article, we will put all this together with some rules and a checklist using a 3-step approach.

WRAP UP WITH RULES PART V

We are going to wrap this system up with rules to be applied on the daily charts. Trending market (red GMMAs are showing good angle and separation): 1. Use 100 pip stop loss. 2. Price action must not be heading for 89, 144, or 200 EMAs or red GMMAs. 3. Buy or sell using the 8, 3, 3 Stochastic oscillator moving away from being oversold or overbought. 4. Only buy or sell going with the trend, buy the dips in an uptrend or sell the rallies in a downtrend. Never enter a position in a counter trend market - trying to row upstream. 5. Buy or sell using the Stochastic Momentum Index when the daily SMI is the same color as the weekly SMI (or SMI weekly window plot). 6. Move stop loss up to entry point as soon as possible and continue to step it up and let price action take you out of the trade.

Non-trending market (red GMMAs together not showing angle and separation):

1. Use 100 to 150 pip stop loss. 2. Price action must not be heading for 89, 144, or 200 EMAs or red GMMAs, or must have room to move before hitting them. In such case set a limit at that level and use a 75 pip stop loss. 3. Buy using the Stochastic Momentum Index (SMI) daily signal (red and green) and the weekly SMI signal (black and baby blue). When Daily SMI is green and not at or above the +60 (extreme overbought) and the weekly SMI signal is baby blue.

4. Sell using the Stochastic Momentum Index (SMI) daily signal (red and green) and the weekly SMI signal (black and baby blue). When Daily SMI is red and not at or below the -60 (extreme oversold) and the weekly SMI signal is black. 5. Move stop loss up to entry point as soon as possible and continue to step it up and let price action take you out of the trade. *Note you may have the weekly Stochastic Momentum Index (SMI) plotted in another window as a red and green line.

Daily 3 Stochastic System Complete This will show you how I use my system with all the charts, indicators and checklist.

Step 1: The first thing I do is go through all 20 pairs and mark any possible trades by putting a checkmark on my list. I always have 20 to 30 of these copied and ready to go before I get ready to trade.

Illustration I

Step 2: The next thing I do is go back and look at the marked charts of any currency pairs that I checked off as a possible trade.

Illustration 2

Here I plot 3 charts on one screen - the 4 hour chart, daily and weekly chart. You can also see all 5 of our indicators plotted with the two optional confirming indicators compressed down. Stochastic Oscillator (STO) Relative Strength Index (RSI) {compressed down} Moving Average Convergence Divergence (MACD) {compressed down} Stochastic Momentum Index (SMI) Guppy Multiple Moving Average (GMMA) {compressed down} Step 3: Check your trades every day and move your stop up to lock in profits. Keep an eye on the daily SMI for color change or the extreme 60% levels (dotted line at +60 and -60 on the daily and weekly charts).

Checklist:

Date:

Go buy/sell Master Chart Analysis

Daily Guppy Master 1

03---EUR/USD [____] [____] _________________________________________

05---GBP/USD [____] [____] _________________________________________

04---USD/CHF [____] [____] _________________________________________

05---USD/CAD [____] [____] _________________________________________ Daily Guppy Master 2

03---USD/JPY [____] [____] _________________________________________

04---EUR/JPY [____] [____] _________________________________________

04---NZD/USD [____] [____] _________________________________________

04---AUD/USD [____] [____] _________________________________________ Daily Guppy Master 3

05---EUR/GBP [____] [____] _________________________________________

05---EUR/CHF [____] [____] _________________________________________

07---AUD/JPY [____] [____] _________________________________________

08---CHF/JPY [____] [____] _________________________________________ Daily Guppy Master 4

09---CAD/JPY [____] [____] _________________________________________

09---NZD/JPY [____] [____] _________________________________________

09---AUD/CAD [____] [____] _________________________________________

09---EUR/CAD [____] [____] _________________________________________ Daily Guppy Master 5

09---GBP/JPY [____] [____] _________________________________________

12---AUD/NZD [____] [____] _________________________________________

12---GBP/CHF [____] [____] _________________________________________

12---EUR/AUD [____] [____] _________________________________________

DAILY 3 STOCHASTIC SYSTEM SETTINGS

You can use this setup on the daily and weekly charts. Exponential Moving Averages applied to Close of price 200 EMA make this a black thick solid line 144 EMA make this a black thin long dash 89 EMA make this a black thin doted line Guppy EMAs (GMMA) applied to Close of price 6 fast blue Thin Solid EMA lines 3, 5, 8, 10, 12, 15. 6 slow red Thin Solid EMA lines 30, 35, 40, 45, 50, and 60. I like to plot these in another price window by themselves to expand them over the whole chart. Indicators Stochastic “STO” make settings 8, 3, 3 Nbr periods 8, %K3, %D3 Up movement blue for both lines and down movement red for both lines, make them thick so it’s easy to see. Horizontal Line at 50 mark dotted line. Stochastic Momentum Index (SMI) 10,3,5,3 Make SMI 1 color up green and color down red and #3 thickness solid line. Make Signal 1 invisible. Signal method simple and apply to close.

Note this indicator is hard to find, it’s at the IT-Finance charts, and you will need to see if it’s at any other charts. Add line at +60 and -60 a dotted line. Stochastic Momentum Index (SMI) 50,15,5,3 Plot this on the same window as the 10,3,5,3 above. Make SMI color up baby blue and color down black #2 thickness solid line. Make Signal #2 invisible. Signal method simple and apply to close. Optional Confirming indicators

Relative Strength Index (RSI) RSI 14 make up green and down red, make line very thick so easy to see. Horizontal Line at 50 mark dotted line. MACD Moving Average Convergence/Divergence 12, 26, 9short term MA 12, Long term MA 26, Signal nbr periods 9. Make Signal line red solid line #3 and MACD line blue solid thickness # 3. MACD Histogram light green going up and light orange going down. I hope you find this information helpful in your trading. Feel free to send me any comments or suggestions. I would like to know how you are doing.

Though the system is illustrated on Forex market, it can be applied to any markets. Traders need a good charting software to start with. I recommend Amibroker for Indian traders. You can purchase Amibroker directly from us at www.stockmaniacs.net.

For more details please feel free to contact me.

Indrajit Mukherjee CEO & Founder www.stockmaniacs.net Mobile: +91-9674321856 Phone: +91-33-65482883, +91-33-30619872 Twitter: http://twitter.com/#!/stockmaniacs Facebook: http://www.facebook.com/stockmaniacs