StockWerld Technical Analysis Education

The "Stochastic" indicator.

The Stochastic Oscillator is displayed as two lines. The main line is called "%K." The second line, called "%D," is a moving average of %K. The %K line is usually displayed as a solid line and the %D line is usually displayed as a dotted line.

There are several ways to interpret a Stochastic Oscillator. Three popular methods include:

1) Buy when the Oscillator (either %K or %D) falls below a specific level (e.g., 20) and then rises above that level. Sell when the Oscillator rises above a specific level (e.g., 80) and then falls below that level.

2) Buy when the %K line rises above the %D line and sell when the %K line falls below the %D line.

3) Look for divergences. For example, where prices are making a series of new highs and the Stochastic Oscillator is failing to surpass its previous highs.

The "MACD" indicator.

The Moving Average Convergence Divergence (MACD) Trading Method is a price momentum indicator developed by Gerald Appel. This oscillator is based on the point spread difference between two exponential moving averages of the closing price.

The solid line's are the MACD treding line's. The vertical dashed line's are called the "MACD histogram".

There are several ways to interpret a Stochastic Oscillator. Three popular methods include:

1) Buy or sell when the trending lines cross or the histogram lines cross the zero line (this will always happen simultaneously).

2) Buy or sell when the trending lines alone cross the zero line.

3) Look for important divergences when price moves higher but the MACD histogram lines are lower than the previous peak, or when price moves lower but the MACD histogram bars are shorter under the zero line

The "Directional" indicator.

The Directional Movement system is composed of 3 lines. The +DI (positive directional indicator line), the -DI (negative directional line) and the ADX (average directional indicator line). Think of the +DI as the "buyers", the -DI as the "sellers", and the ADX as the referee who decides which side is stronger.

Some Trading rules:

Trade only from the long side when the +DI is above the -DI and the ADX is rising

Trade only from the short side when the -DI is above the +DI and the ADX is rising.

The "Williams' %R" indicator.

The Williams' %R indicator uses the price range over a given period of time to establish a center and then tries to spot relative overbought or oversold areas from this center as market turning points.

Its interpretation is similar to the RSI. If the Williams' %R is below -80 a buy should be considered. If the Williams' %R is above -20 a sell should be considered. It should be noted that some analysts suggest using -10 and -90 as signal levels instead of -20 and -80. It is suggested that signals from this indicator be used in conjunction with at least one other indicator.

The "Relative Strength Index" indicator.

The Relative Strength Index (RSI) is a price momentum indicator which depends solely on closing prices. RSI avoids the problems of erratic movement caused by dropping off the old data, the take away number that weakens the Rate of Change and Stochastics indicators.

If the RSI is below 30 a buy should be considered. If the RSI is above 70 a sell should be considered.

The Momentum indicator: You can use the Momentum indicator as a trend-following oscillator similar to the MACD (this is the method I prefer). Buy when the indicator bottoms and turns up and sell when the indicator peaks and turns down. You may want to plot a short-term (e.g., 9-period) moving average of the indicator to determine when it is bottoming or peaking.

If the Momentum indicator reaches extremely high or low values (relative to its historical values), you should assume a continuation of the current trend. For example, if the Momentum indicator reaches extremely high values and then turns down, you should assume prices will probably go still higher. In either case, only trade after prices confirm the signal generated by the indicator (e.g., if prices peak and turn down, wait for prices to begin to fall before selling).

You can also use the Momentum indicator as a leading indicator. This method assumes that market tops are typically identified by a rapid price increase (when everyone expects prices to go higher) and that market bottoms typically end with rapid price declines (when everyone wants to get out). This is often the case, but it is also a broad generalization.

As a market peaks, the Momentum indicator will climb sharply and then fall off-- diverging from the continued upward or sideways movement of the price. Similarly, at a market bottom, Momentum will drop sharply and then begin to climb well ahead of prices. Both of these situations result in divergences between the indicator and prices.