Color Stochastic Indicator

George Lane invented the traditional Stochastic Oscillator in the 1950s. Using an oscillator, this indicator allowed traders to identify the direction of momentum as well as overbought and oversold price levels. The Color Stochastic Indicator is a variant of the traditional Stochastic Oscillator that gives traders additional control over the indicator. It also indicates price levels that are overbought or oversold by changing the color of one of its stochastic lines.

What is the Color Stochastic Indicator?

The Color Stochastic Indicator is a momentum indicator that is based on the Stochastic Oscillator, one of the most prominent oscillators. This indicator displays two lines that oscillate between 0 and 100. This indicator’s lines change color to detect overbought and oversold markets. It draws a red line to represent an overbought market and a lime line to represent an oversold market, although the color settings can be modified to suite the user’s taste.

Setting up the Color Stochastic Indicator
Setting up the Color Stochastic Indicator

Color Stochastic Strategy

The Color Stochastic Indicator, like the traditional Stochastic Oscillator, uses a similar mechanism to compute its stochastic lines. The distinction is that it offers multiple momentum computation methods, including Simple Moving Average (SMA), Exponential Moving Average (EMA), Smoothed Moving Average (SMMA), and Linear Weighted Moving Average (LWMA). The color of the faster stochastic line changes to red when it is above 80 and lime when it is below 20 (this can be changed in the indicator’s settings). This indicator has numerous parameters that allow you to change the properties of its stochastic lines. “KPeriod,” “DPeriod,” and “Slowing” refer to the number of bars used in the indicator’s computation, similar to the original Stochastic Oscillator. The “MAMethod” formula adjusts the type of moving average utilized. The terms “overbought” and “oversold” refer to the levels at which the color of the faster stochastic line changes to signify overbought and oversold market conditions.

Buy Signal

The following could be your checklist for a buy trade:

  • When the faster stochastic line changes to lime.
  • When the faster stochastic line crosses above the 20 signal-level.

Once these events occur:

  • You could open a buy position after you confirm your entry with bullish candlestick patterns.
  • You could set your stop loss just below the nearest swing low.
  • You could set your take profit at the nearest resistance zone, or you could exit trade when the indicator enters the overbought region.
  • For good risk management, I would only consider trades with a risk to reward ratio of at least 1:2.
Color Stochastic Indicator Buy Setup
Color Stochastic Indicator Buy Setup

Sell Signal

The following could be your checklist for a sell trade:

  • When the faster stochastic line changes to red.
  • When the faster stochastic line crosses below the 80 signal-level.

Once these events occur:

  • You could open a sell position after you confirm your entry with bearish candlestick patterns.
  • You could set your stop loss just above the nearest swing high.
  • You could set your take profit at the nearest support zone, or you could exit trade when the indicator enters the oversold region.
  • For good risk management, I would only consider trades with a risk to reward ratio of at least 1:2.
Color Stochastic Indicator Sell Setup
Color Stochastic Indicator Sell Setup

Color Stochastic Pros & Cons

Pros

  • The Color Stochastic Indicator informs the traders on potential overbought and oversold levels.
  • The indicator could be used to predict possible trend reversal and trend correction zones.

Cons

  • The color change of the Color Stochastic Indicator may eventually turn out to be a minor trend correction in some cases.
  • This indicator may not meet the trader’s expectations in a narrow-ranging market on smaller timeframes.

Conclusion

When trading mean reversals from overbought and oversold price levels, the Color Stochastic Indicator can be a highly useful indicator. This indicator’s default parameters are geared at longer-term trends and oscillations. Users can change this to provide faster signaling. It is also advisable to utilize this indicator in conjunction with a longer-term trend and price action.

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