The trading strategy that we are going to present below was initially created to trade the S&P 500 index, but it can also be applied in other markets such as Forex, since it is based on price action and technical trading signals.
In this section, we present a trading technique developed and used to trade the S&P 500 stock index, which is well described by Charles Le Beau and David W. Lucas in their book Day Trading Systems & Methods. It is based on an easily identifiable price pattern (3-bar pattern) in combination with the Stochastic Oscillator technical indicator. As we will see during the description, it is a simple and easy to apply strategy, which only requires the exact application of the rules.
According to the authors, this guideline should be used to search for floors (minimum points in the price) and ceilings (maximum points in the price) in the markets.
Below are the various rules of the strategy, including the steps to identify the 3-bar price pattern.
Indicators and system configuration
- 1 bar/candle price chart on the 30-minute time frame.
- 1 stochastic oscillator with standard configuration and with overbought (70) and oversold (30) levels marked in the window, as shown in the following image.
Rules for opening buy and sell positions
- Use a 30-minute time frame price chart on the S&P 500 index along with a 9-period slow stochastic oscillator.
- Prepare to open the buy position at the close of bar 3 if the following conditions are met:
- The low of bar 2 is lower than the low of bar 1 and the close of bar 2 is lower than the low of bar 1. (market is still in a downtrend).
- The low of bar 3 is higher than the low of bar 2 and the close of bar 3 is higher than the close of bar 2 and the close of bar 1. (possible trend change from bearish to bullish).
- Open the buy position if the 3-bar pattern is accompanied by a stochastic oscillator reading of less than 30.
- Prepare to open the sell position at the close of bar 3 if the following conditions are met:
- The low of bar 2 is higher than the low of bar 1 and the close of bar 2 is higher than the low of bar 1. (market is still in an uptrend).
- The low of bar 3 is lower than the low of bar 2 and the close of bar 3 is lower than the close of bar 2 and the close of bar 1. (possible trend change from bullish to bearish).
- Open the sell position if the 3-bar pattern is accompanied by a Stochastic Oscillator reading greater than 70.
Management of open positions
- Place a protective stop a tick or two at the end of the pattern. If this stop is too far away, it is best to place a stop based not on ticks but on dollars, that is, based on a certain amount of money.
- Exit the position if we have the opposite pattern to the one that created the entry at the close of bar 3.
Real example of the 3-bar system for the S&P 500
Below is a graphical example of a bullish 3-bar pattern that offers a good buying opportunity:
Note: Although the strategy was originally designed to trade the S&P 500 Stock Index, it can also be used in other markets, such as Forex, as it is based on common price patterns and technical indicators.
You can have access to more trading methodologies for different markets in the following section: Forex Trading Systems
