A stochastics indicator is used as a momentum gauge for technical analysis of commodities, stocks, currencies, etc. The basic principle behind this successful indicator is that, the price range using both a specific closing day and time span can allow investors to determine swing and momentum. This article will discuss both slow moving and fast moving stochastics (Stoch) in its most basic concepts.
Stochastics Indicator: Stoch %K and Stoch %D
Before any further discussion, it is important to point out the basics. There are two stochastic lines. % K is the main line and is drawn as a solid line. %D is the moving average, and is drawn as broken lines.
Stochastics Indicator: Fast (Stoch %K)
%K is the fast stochastic oscillator. %K calculates the proportion of 2 closing price statistics. Simply put it is the difference between the most up to date closing price and the price lowest within a specific period.
Stochastics Indicator: Slow (Stoch %D)
%D is the slow stochastic oscillator. %D determines simple moving averages. As a general rule this means s=3.
Stochastics Indicator: Application 1
The first scenario involves %D acting as a trigger or a line that signals a reversal. When %K crosses up through %D, a buy signal is imminent. However, when %K crosses down through %D, a sell signal is called for. The problem is in some cases the crossovers are spaced too near each other that a veritable whipsaw occurs. To remedy the situation experts advise to schedule your movement with an oversold and/or overbought pullback. This allows you time your trades only after a trough or after a peak in %D. In addition, if prices are volatile you can make use of the simple moving average of %D. The result is smooth, fluctuation free or fluctuation minimized prices.
Stochastics Indicator: Application 2
The second scenario puts emphasis on %K and %D levels over 80 RSI and Below 20 RSI. The former is interpreted as overbought territory while the later is interpreted as oversold territory. Proponents of this method recommend timing your buying and your selling based on the theory that once overbought and oversold levels are reached reversal is imminent. Hence, the key is timing movement as soon as reversal starts and prior to it leveling out.
A Third Option
Another method proposed by seasoned traders and experts alike is to watch for divergence, or that point when stochastics move opposite from the price. This is supposed to be an indicator that the momentum is slowing down and a reversal is possible. Of course, it is possible that it will start trending. Tip; proponents opine that waiting for the cross above 20 or below 80 before moving increase your chances of actually catching or trading in divergence.
Stochastics are reliable indicators that beginners and expert traders utilize in order to determine action and/or inaction. However, for best results it is best to employ other indicators for checking. Having a stop loss order, just in case you actually read the charts wrong is also a good idea. Remember, you cannot win them all, but you can prevent yourself from losing an embarrassing amount by planning ahead and cutting your losses.