Saturday, April 5, 2008

Bollinger Bands and Slow Stochastic Combination

Using a single indicator will fail you in most of the place when they are become unreliable. MACD for example is lagging and it takes so much of your time to wait for the right moment which can hardly come. This is one of the example explained the flaw of a single indicator that can discouraged you if they are not solved. Therefore this time I am going to discuss how combination of indicators can help to reduce the flaw of each indicator and put together the right combinations to increase their effectiveness.

As discuss in the earlier blog, Bollinger bands is used to measure the level of support and resistance where the market usually fluctuates. In other words the market will move ups and downs inside the area of the Bollinger bands. However in reality as you may notice on your trading chart, the market moves not necessarily exact within the bands area (support & resistance level). This is cause by the effect of emotions involves in everyday trading which resulting the market to create overbought and oversold patterns that goes beyond the Bollinger bands area. See picture below.

The interesting part of overbought/oversold position is because it is emotional therefore the effect is very short. And the chances of the market movement to make a correction back to its normal position are very high. Despite of this in most cases inexperience traders would execute their trading ahead of the overbought/oversold positions which can create emotional doubts that they are making the wrong decision. Further more they are loosing some precious pips from the short-term movement.

Now the point is how can you improve you trading decisions by reducing the amount of such errors and utilize the situation to harvest precious pips. One of the ways experience traders usually do is by adding another indicator called Slow Stochastic. As discussed earlier the slow stochastic advantage is the movement is the most recent along with the market movement. Therefore the fluctuations of the market generally move according to the slow stochastic fluctuations.

By using the two indicators we can have better signals of twists and turns of the market. As the market generally move inside the area of the Bollinger bands as but it is also frequently move beyond the bands area. In order to reduce the possibility of error not to make decision ahead of the market we use the slow stochastic signals using the following strategies.

  • Do not open position on the top or bottom of the Bollinger bands before stochastic has not signals any reversal.
  • Open a position when the candlestick goes beyond the band area and at the point of intersection of the slow stochastic.
  • These two combinations can be improved better accuracy by adding MACD indicator.

However yet again I have to remind you the best use of these indicators will be better if you have in-depth understanding of it on multiple time frames application.

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