Choppy, indecisive markets, volatile price action, and platforms are the perfect market conditions to pull out the forgotten Stochastic Indicator and put it to use. Stochastic shines during difficult market conditions because it was written during a very choppy volatile market condition. It is designed for sideways price action, analysis of trading ranges, and platforms.
Stochastic is ideal for short term trading and when viewed from a new perspective can give you many new ways of looking at your stock picks and how price is behaving.
Here is a list of patterns most traders do not know:
1. Stochastic Floating Pattern
2. Stochastic angle of descent with lower highs and lower lows on the stochastic cross over
3. Stochastic compression patterns
4. Stochastic angle of ascent with higher highs and high lows on the stochastic turn
5. Extreme Stochastic Patterns
6. Failure to Peak Patterns
7. Failure to Trough Patterns
Most traders use stochastic simply as an overbought or oversold indicator but it has far more value than just signaling the overbought or oversold range of a stock. It can help you with:
1. Triangle identification prior to a breakout
2. Compression identification prior to a major gap
3. Weakening sideways patterns prior to a breakdown
4. Strengthening sideways patterns prior to a breakaway to the upside
5. Platform compressions prior to a breakaway to the upside
Let's study a chart.
LOW is moving sideways at the August lows support that have provided solid support for most stocks for over a month now. This sideways action is fairly typical of many stocks hovering near the August lows.
We can first study it with the TT Volume bars which are color coded to assist in determining if volume is stronger to the upside or if volume is stronger to the downside. Color coding volume really helps speed up the analysis of volume which is one of the 3 pieces of data that we get from the exchanges, dark pools, and data feeds such as Reuters used by MetaStock.
Volume is critical for the first step of the analysis. TTQA tells us whether institutions are accumulating in the secretive dark pools or if they are distributing the stock. This tells us that there was some distribution in the summer but now accumulation is intermittent.
Chart 1
Now let’s apply Stochastic.
Stochastic is designed for sideways price action but instead of just focusing on the overbought or oversold we are going to look for other stochastic patterns to guide us.
Below is the same chart, same timeframe with stochastic. I have drawn lines and arrows to show you the failed trough pattern (arrow) and the triangle pattern that is forming. You can clearly see with stochastic that the price is beginning to compress and stochastic shows a definitive symmetrical triangle pattern indicative of breakout patterns.
Before the failed trough there was the typical overbought and oversold oscillation that most traders look for in stochastic.
Chart 2This chart also shows several other stochastic patterns mentioned above.
Running lower highs and failed troughs into a floating stochastic pattern typical of a momentum run, in this instance to the downside.
Chart 3Stochastic is a true price oscillator and has been used for many decades to determine overbought and oversold conditions of sideways patterns. But there is so much more you can do with this indicator once you learn all of its more subtle and over overlooked patterns and nuances.
Trade wisely,
Martha Stokes, C.M.T.
Member of Market Technicians Association
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader® Stock Market Courses
http://technitrader.com
MetaStock Partner
©2011 Decisions Unlimited, Inc.
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