Stochastic MACD Strategy is based on one of the most common combinations of indicators. The strategy combines popular MACD trend-following strategy and classic Stochastic rebound strategy.

## Strategy

It is known that Stochastic Indicator works badly in trending markets. In other words, trend distorts Stochastic Indicator readings and produces false signals. In its turn, MACD indicator gives false signals during stagnating, lateral movements of the market. The combination of this two indicators aims to take the best qualities of each.

### Short description of Stochastic

There are two components to the Stochastic oscillator the %K and the %D lines. The %K called Stochastic line, is the main line and represents Stochastic oscillation of the price for the last N bars. %D or the Signal line represents Moving Average of the %K line and shows momentum and trend of the indicator. As the classic oscillator, Stochastic ranges between 100 and 0. Ground rules for the Stochastic Oscillator:

- Stochastic line %K drops below 20 – asset is oversold; %K line rises above 80 – asset is overbought
- %K line is higher than %D line – asset is in uptrend; Stochastic line is lower than %D line – downtrend

### Description of MACD

MACD consists of two components: MACD histogram and Signal line. MACD histogram is the difference between two Moving Averages. The signal line is the Moving Average of the MACD histogram; it is used to spot trend and peaks in the indicator. As MACD represents the difference between two MA, it is not ranged between max and min values. MACD oscillates about the zero line. Rules for MACD:

- MACD histogram higher than zero line – asset is in uptrend; MACD histogram lower
- Histogram crossing the Signal Line from bottom-up – uptrend signal or end of the downtrend; MACD histogram crosses the Signal line from above-down – downtrend or end of the uptrend

### Rules for the strategy

The strategy consists of two logical steps: first – determine trend direction with the help of MACD Indicator; second – determine entry point within trend direction with the Stochastic Oscillator Indicator.

Since we are using MACD as trend filter and Stochastic as trade trigger, MACD should have a bigger period than Stochastic Oscillator. For intraday trading on forex pair EURUSD we recommend the following settings:

Timeframe – 15m; MACD (24, 200, 14); Stochastic (9,5,3)

## Setup

- Any trading instrument is suitable
- To avoid the impact of market noise we recommend to use time frames higher than 15 min;
- Install Stochastic Oscillator (we recommend following settings Stochastic (9,5,3);
- Install MACD (we recommend following settings MACD (24,200,14);

Longer period MACD (24,200,14) shows weekly trend direction. Stochastic (9,5,3) shows entry points.

### Entry rules

The strategy follows simple rules: MACD shows current trend direction; Stochastic Oscillator shows entry points; Trades are open in the trend direction.

Buy signal:

- MACD higher than 0 level
- Stochastic line %K is greater %D and crossing 20 level from bottom-up

Sell signal:

- MACD lower than 0 level
- Stochastic line %K is lower than %D crossing 80 level from above-down

### Exit rules

The strategy allows several exit rules. In addition to the stop loss and take profit Stochastic Oscillator will be used to determine an end of the trading impulse.

#### Stop Loss

There are several rules to evaluate Stop Loss, which underlay different risk levels. Usually, Stop-Loss set to the support levels and pivot points. These rules are listed for the Buy signal, for the Sell signal rules should be vice versa.

- Closest lower Pivot Point
- Minimum of the last bar (Suitable for the high time frames, 4h, 1D, 1W)
- Minimum of the current day
- Current Price – k* ATR (Average True Range show average price motion; k between 2 and 5)

#### Take Profit

Take Profit is the desired level of profit and must correlate with Stop Loss level. One of the most important indexes of the strategy is relation SL/TP. This relation is called risk/reward level of the strategy. (rules are for the Buy signal):

- Last Pick (Visual Pick of the price for the reasonable period)
- Closest upper Pivot Point
- Maximum of the last bar (Suitable for the high time frames, 4h, 1D, 1W)
- Current price + k*Standard Deviation (Standard Deviation indicator stands for an average price motion; k between 0.5 and 1)
- Current price + k*ATR (ATR – average true range, calculated on a different principal than Standard Deviation; k between 0.5 and 2)

#### Early exit rules

In this strategy, Stochastic Oscillator reflects intraday price peaks and reversals on which trader enters the market, reverse signals of this indicator serve for exit signals. Nevertheless, MACD Indicator, which shows trend direction also should be considered.

Rules for closing the Buy trade:

- Stochastic line %K crossed 20 level from above-down
- Line %K crossed signal line %D from above-down
- Line %K reached 80 level and crossed it from above-down
- MACD indicator loses momentum or crosses zero level from above-down (MACD histogram rapidly approaching zero. Mainly determined visually)

## Examples

This chart demonstrates several Buy signals in a row, all closed by the Early exit rules. Note that decreasing MACD accompanies calming market.

The chart demonstrates sell trades during a downtrend. Stop Loss level are 60 pips, according to the weekly maximum and ATR level; Take Profit are 30 pips; All trades were closed by the early exit rules.

## Pros

Straightforward and profitable strategy, works best in trending markets.

## Cons

Strategy gives false signals during stagnating market periods.

## Bernard Guguen

What are the settings you recommend on a daily chart ,

for a combined MACD + STOCHASTIC strategy?

I thank you for your kind advice,

Bernard Guguen

## admin

Hi.

Usually, the settings for indicators are selected based on some logical conclusions regarding the timeframe and the asset. For example, for the EURUSD Daily chart we use MACD with Year – Month (280 trading days in a Year and 22 trading days in a Month) period and Stochastic for two weeks (10 trading days).

MACD(22, 280, 14)

Stochastic(10, 5, 3)

Best Regards

## user meme

Hi Admin. Thanks for your posting. However, let’s be realistic based on your SELL and BUY example charts; you don’t have good enough filters. Look at the bottoms on the price AND on the histogram. See how they are HIGHER bottoms? (except after the 2nd sell). So although your big time frame MACD stays below 0, indicating a downtrend, these higher lows along with price making weak moves and also with higher lows is a very good sign of weakness and impending trend change. I suspect your MACD might work a bit better with 24,100, 14 or even 24,50,14. I did not look at a chart, but it would not surprise me to find out that the whole period displayed in your sell chart is nothing but a weak pullback of an uptrend, hence, the rather flat to upward direction of price. Similarly, after your last BUY order, price simply goes flat. So what happened? You can see between your 3rd and 4th buys that price tops out AND the MACD histogram also tops out. Then the next high, after your 4th buy, is a LOWER high both in price AND the MACD histogram, showing weakness of the uptrend (and even more likely that it has now gone into a downtrend), even though the histogram is far above 0. Your first 3 buys were good because price was making higher highs AND higher lows, and the MACD histogram agreed with higher highs as well.