Trading Educators Blog
Hey Joe! I know you use Stochastics quite often and I want to know why. Is there some "magic" to it? Is a Stochastic indicator better than any other?
First, let's define what a Stochastic Indicator is: Stochastics is a momentum indicator comparing a particular closing price of an under lying asset to a range of its prices over a certain period of time. The sensitivity of the oscillator to market movements is reducible by adjusting that time period or by taking a moving average of the result. It is used to generate overbought and oversold trading signals, utilizing a 0-100 bounded range of values.
Stochastics, like the RSI indicator, is a range-bound oscillator. However, where the RSI is calculated based on average gains and losses, Stochastics compares the current price level to its range over a given period of time. Prices tend to close near their highs in an uptrend and near lows in a downtrend. Therefore, price action that moves further from these extremes toward the middle of the range is interpreted as an exhaustion of trend momentum.
A stochastics value of 100 means that the current session closed at the highest price within the established time frame. A stochastic value of 80 or above is considered an indication of an overbought status, with values of 20 or lower indicating an oversold status.
I don't use Stochastics very often. I sometimes use it in conjunction with a volatility indicator, and I teach the use of Stochastics mostly to show students something they seem to have trouble seeing with only their eyes. I am primarily a chart reader and have learned how to trade simply by trading what I see. In fact, I invented the term "Trade what you see, not what you think" many years ago.
The main reason to use any indicator is to show you something that is not easily seen with just your eyes. There is no magic to using Stochastics. It works quite well for overbought and oversold conditions in a sideways market. It does not work well when prices are trending. Stochastics are not any better than any other indicator when used as a momentum indicator. I like it because I'm used to it, and have found it to be very valuable in teaching others in my webinar: Trading With More Special Setups.
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