Stochastics

Stochastic Fast

Stochastic Fast plots the location of the current price in relation to the range of a certain number of prior bars (dependent upon user-input, usually 14-periods). In general, stochastics are used to measure overbought and oversold conditions. Above 80 is generally considered overbought and below 20 is considered oversold. The inputs to Stochastic Fast are as follows:

• Fast %K: [(Close - Low) / (High - Low)] x 100
• Fast %D: Simple moving average of Fast K (usually 3-period moving average)

Stochastic Slow

Stochastic Slow is similar in calculation and interpretation to Stochastic Fast. The difference is listed below:

• Slow %K: Equal to Fast %D (i.e. 3-period moving average of Fast %K)
• Slow %D: A moving average (again, usually 3-period) of Slow %K

The Stochastic Slow is generally viewed as superior due to the smoothing effects of the moving averages which equates to less false buy and sell signals. A comparison of the two stochastics, fast and slow, is shown below in the chart of the Nasdaq 100 ETF (QQQQ):

As will be shown on the next page, Stochastics offer clear buy and sell signals and help in determining overbought or oversold price conditions.

Next :  Stochastic Price Divergences

Stochastics Buy & Sell Signals

Stochastics Buy Signal

When the Stochastic is below the 20 oversold line and the %K line crosses over the %D line, buy.

Stochastics Sell Signal

When the Stochastic is above the 80 overbought line and the %K line crosses below the %D line, sell.

Stochastic Fast buy and sell signals are illustrated below in the chart of the E-mini S&P 500 Future:

Stochastic Slow is presented below in the chart of the E-mini Russell 2000 Futures contract. Notice how much smoother the %K and %D lines are and how many fewer false signals were given by the Stochastic Slow than were given by the Stochastic Fast indicator.

 

In addition to giving clear buy and sell signals, the Stochastic technical analysis indicator is also helpful in detecting price divergences and confirming trend.

Next : Stochastic Price Divergences

Stochastic Price Divergences

Stochastics can be used to confirm price trend. In the example below of the Nasdaq 100 ETF (QQQQ), the Stochastic indicator spent most of its time in the overbought area. When Stochastics get stuck in the overbought area, like at the very right of the chart, this is a sign of a strong bullish run. Signals to sellshort would be ignored; however, before the signal not to short was given, many losses unfortunately would have accrued from failed shorting attempts on the left half of the chart.

A powerful and more common occurence is Stochastic divergences. The chart below of Gold futures illustrates Stochastic divergences and confirmations:

Low #1 to Low #2

The Stochastic Slow confirmed the upward movement of gold futures prices by making a higher low.

High #1 to High #2

Gold futures rallied to make a higher high; however, the Stochastic Slow indicator failed to make a higher high, instead it made a lower high. This divergence coupled with a trendline break in the price of gold would be a strong warning to futures traders that the recent rally had probably ended and any long futures positions should be exited or at least scaled back.

Low #3 to Low #4

Gold prices continued its downward tumble, making a lower low at Low #4. On the other hand, the Stochastic Slow indicator was signaling a higher low. This bullish divergence would have warned traders to exit their shortsells, the price of gold had a strong potential of bottoming.

Williams %R and Trends

The Williams % R indicator is extremely useful and profitable during sideways, non-trending markets. However, during trends, the Williams % R indicator does not fare as well, leading to losses. Nevertheless, the Williams % R indicator does give tell tale signs of strong trends that can easily be identified by traders for profit. The following chart of the Nasdaq 100 ETF (QQQQ) illustrates Williams % R’s ability to detect such trends:

 

 

As the chart of the QQQQ illustrate, when the Williams % R indicator stays in the oversold area (below 20) and any bullish rally barely registers with the Williams %R (i.e. fails to go above 80), then the downtrend is strong and a trader should not go long the market.

Similarly, when the Williams %R indicator stays in the overbought area (above 80) and any attempt at a downturn fails to send the indicator into oversold territory (i.e. fails to go below 20), then the uptrend is strong and a trader should not go short.

The Williams %R is a versatile technical indicator used by many; the indicator gives easily intepreted buy and sell signals, and also informs traders whether or not a market is likely overbought, oversold, or trending strongly. The Stochastic indicator would be a logical next step for investigation.

Williams %R

Williams %R is an overbought and oversold technical indicator that can give easy to interpret buy and sell signals. Williams %R is very similar to the Stochastic Fast indicator as the chart below will illustrate:

Like Stochastics, the Williams %R indicator gives easily interpreted buy and sell signals, as is demonstrated in the chart below of the Nasdaq 100 exchange-traded fund QQQQ:

Williams %R Buy Signal

When the Williams %R indicator is below the oversold line (20) and it rises to cross over the 20 line, then buy.

Williams %R Sell Signal

Sell when the Williams %R indicator is above the overbought line (80) and then falls below the 80 line.

In addition to giving clear buy and sell signals, the Williams %R indicator can help identify strong trends; this is discussed on the next page.

Next : Williams %R and Trend

Pivot Points

Pivot Points are used to project potential support and resistance levels. The main time periods used are daily, weekly, and monthly pivots. The formula for the daily pivot point, support, and resistance is shown below :

• Pivot Point = [Yesterday's High + Yesterday's Low + Yesterday's Close] / 3

A 15-minute chart of the mini-Dow futures contract and the corresponding floor trader pivots are shown below:

Support Levels

• S1 = [Pivot Point * 2] – Yesterday’s High
• S2 = Pivot Point – Yesterday’s High + Yesterday’s Low
• S3 = S2 – Yesterday’s High + Yesterday’s Low

Resistance Levels

• R1 = [Pivot Point * 2] – Yesterday’s Low
• R2 = Pivot Point + Yesterday’s High – Yesterday’s Low
• R3 = R2 + Yesterday’s High – Yesterday’s Low

To calculate weekly or monthly numbers, simply replace "yesterday’s" with "last week’s" or "last month’s" high or low.

Pivot Point Example

In the chart above, and going from left to right, Resistance Level 1 (R1) held and the Dow Jones Industrial Average mini-Dow futures contract reversed course and headed downward.

After that, the next potential support was at the Pivot Point. However, the mini-Dow broke through the Pivot Point. Notice that when the mini-Dow attempted to reverse course, it was rejected by the Pivot Point now acting as resistance. An important technical analysis concept is that when resistance is penetrated the prior resistance then becomes support. Similarly, when support is penetrated the prior support then becomes resistance

From there, the next support was Support Level 1 (S1). S1 held strong and the mini-Dow reversed direction yet again.

The next resistance line was at the Pivot Point, which failed.

The trading day ended by the mini-Dow testing the Pivot Point, now acting as support, which subsequently held. From there, the index rallied on into the close.

More ways to use Pivot Points is discussed on the next page.