Stochastics

This will be the only computer generated technical study that I will discuss, as it is the only one I use. Beware using all the bells and whistles available in todays trading platforms. Less is more in my opinion. Also, when all the techniques in this section are used together, stochastics can be the final piece of the puzzle that will confirm or refute if a good trading opportunity is present.

The stochastic indicator basically measures the relative position of the closing price within a given interval. If you take the price movement of the past five trading days, a slow stochastic (which is the type I use ) will give you the relationship of the current price to the range of the previous five days. It allows the technical trader to be aware of overbought and oversold conditions in a specific market. A reading below 25 is considered oversold and a reading above 75 is considered overbought. I won't get into exactly how this calculation is achieved as it is more important to understand how to use it than it is to understand the formula for it.

The stochastic method relies on the assumption that prices tend to close near the upper part of the trading range during an uptrend and near the lower part of the trading range in a downtrend. Keep in mind the most basic definition of an uptrend is a series of higher lows and higher highs. As a trend approaches a turning point, the price closes further away from the extremes. For example, further away from the highs in a rising market and further away from the lows in a declining market.

The objective of the slow stochastic is to identify these points in the trend since this indicates a reversal may be at hand. For practical purposes, you would look to go long in a market when stochastics are turning up from an oversold condition.

Notice the turn in the market price and the stochastics from an oversold condition. These are the scenarios to look for.

And go short when reading are turning lower form an overbought condition.When the blue line crosses over the red line, that is considered a valid signal or change in market direction. However, stochastics are not meant to be used alone as trading signals. I recommend using them to confirm the rest of your technical research. Hopefully you will use all the trading techniques covered in this section in conjunction with a stochastic indicator. When all signs point in the same direction, you have an excellent chance for a winning trade. Even if the trade fails, if all the trading rules were followed, you should have had a minimal loss at worst.

Usually overbought and oversold readings call for a reversal in price. However, extreme readings near 0 or 100 may call for a continuation of the current trend. In futures trading, there is always an exception to the rule. Similar to price patterns, stochastics can also have patterns that will help you predict where a market may be heading. A move that make s anew daily high while the stochastics do not make a new high, is a divergence and a good signal that a reversal is posible.

Stochastic reading are moving higher while price has gone stagnant. A divergance is taking place and price may follow the indicator higher. A break of the prevailing downward trendline would be a good confirmation of higher prices to come.

Trend Lines | Stochastics | 1-2-3 Formations | Pulling the Trigger

 

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