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Stochastics
Written by: Mystifier |
June 20th,1999 |
Subject: Stochastics
The stochastic indicator is an oscillator that is used in nearly every computerized trading program. The stochastic line is designed to fluctuate between 0 and 100. Reference lines are drawn at 20 percent and 80 percent to mark oversold and overbought areas.
Interpretation
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.
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...
Trading Rules
In a nutshell stochastics measure the ability of bulls or bears to close price near the upper or lower range of the time period in question. I never trade a stock based on one indicator alone but I look at the stochastic read every time I am about to make a play. Some of the things I look for are as follows:
1) A bullish divergence. This is when price continues to set new lows but the stochastic indicator traces a higher bottom than during the previous decline. (See below)
Notice NITE has been in a sidways pattern or channel since early June but stochs have bullishly diverged from price since mid June. This is a sign that the bulls are gaining control of the stock and the odds have it price will follow higher in the short term.
(Also note the classic head and shoulder pattern beginning late may/early June.....it suggests that if $60 is broken to the upside than price should run to $80. This is calculated by taking the distance from the top....or in this case bottom...of the head, which is at $40 to the shoulder height at $60, which is equal to a $20 move. So if the $60 dollar level is broken than another $20 move statistically is probable to $80!)
2) A winding or "coiling" pattern. Notice how the stochastic lines are coiling up like a snake rising for a bite? This is another bullish signal that the bears are losing their grip on the stock.
3) The "stochastic V". This is when stochastics bounce off the 20 line or "oversold" line in a "V" like pattern rather than a "U" shape or rounding bottom pattern. It indicates that many traders had their eye on the stoch and had been waiting for stochs to hit the line to purchase it. Nice sign of underlying support.
One more thing about the stochastic indicator.........it works great in any time frame, intraday, daily, weekly, monthly......or any period you happen to be watching.
Copyright
Mystifier
June 20th, 1999
Some books on the subject are listed below:
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For other selections you may want to browse use the link below:
