Understanding the Stochastic Indicator

[SkyCoder]

Howdy Diane,

Understanding the charts can be confusing because there are lots of little pieces, but the pieces are simple.

In the sticky topic at the top of this forum, Justin has posted a link to the prophet technical analysis glossary. It is an excellent source for a basic introduction to each of the zillion charts that people have invented in an effort to make money from the market. The folks at prophet.net have also published a book with the same format, "Technical Analysis From A to Z", if you prefer paper. And there are the kind folks on this site for specific questions.

Jim

[TheCrack]

Everybody has their own preference, but the following is what I like to use:

Here are the settings I use at Businessweek....
I generally look at the 3month, but will sometimes look at the 1 month or 6 month as well....

http://home.comcast.net/~crackersaka...rtSettings.JPG

[SkyCoder]

Howdy,

A not so short lecture on the calculation and display of the stochastic.
Hope it helps clear up a little bit of the confusion.

The stochastic deals with the closing price as a percentage of the price range over the last N days. For Rule #1 purposes, N is 14.

The fast stochastic calculates and displays two lines of data, the first line is the percentage and the second line is a moving average of the first line.
Line 1 = closing price as % of range for N days
Line 2 = X day moving average of Line 1
Line 1 is called %K, and Line 2 is called %D. If you were to use 14 days to calculate the price range and 5 days for the moving average MSN Money would label the chart as
“Fast Stochastic: 14-Period %K --- 5-Period %D ---“

The slow stochastic calculates three lines of data, but only displays two lines.
Line 1 = closing price as % of range for N days
Line 2 = 3 day moving average of Line 1
Line 3 = X day moving average of Line 2
Note that the 3 day moving average in the calculation of the Line 2 is part of the definition of the slow stochastic and not a parameter. The slow stochastic displays Line 2 and Line 3. Line 2 is called %K, and line 3 is called %D. If you were to use 14 days to calculate the price range and 5 days for the moving average, MSN Money would label the chart as
“Slow Stochastic: 14-Period %K --- 5-Period %D ---“

If you use a 14-3 fast stochastic and a 14-5 slow stochastic, you will notice that the %D line of the fast stochastic is identical to the %K line of the slow stochastic. (MSN users will have to resort to multiple windows.) (Yahoo Finance beta users will note that the hidden moving average is longer than 3 days.) (BusinessWeek users only get a one line display instead of the two line display needed for Rule #1.)

Most charting packages only allow two parameters for the slow stochastic, the period for the price range (Line 1) and the period for the second moving average (Line 3). When a charting package has three parameters for the slow stochastic, it is allowing you control over the moving average in Line 2. (A three parameter stochastic is sometimes called a Full Stochastic.) The Rule #1 settings for a three parameter slow stochastic should be 14,3,5.


Jim

[kitchenboy]

I don’t really understand the math, but I think I know how to do it.

In the book (p 205-207), Phil recommends buying or selling based on when the lines cross. He uses the 20/80 thresholds as conformation of that buy/sell signal.

[roberth]

You are discussing the MACD (8,17.9) in the stochastic thread.

[kitchenboy]

Originally Posted by roberth

You are discussing the MACD (8,17.9) in the stochastic thread.

Um...I don't think so.

For example, in my book, on page 205, it says "one of these lines is called the ‘buy line,’ and the other is called the ‘sell line.’ When the buyline crosses and gets on top of the sell line (I inserted an upright triangle), the stochastic is signaling that the stock is going from oversold (too many sellers) to overbought....”

[roberth]

Some of the discussions keep referring to 8, 17 and 9. All are parameters values used in the MACD in the book not the stochastic.

[npg]

Guys,

I got severly burned trading on lagging indicators. All MACD and SlowStoch tell u is what the mood is, but it is no indication whatsoever of its future moves.

Like somebody else pointed out, price action is a far better approach (although still risky).

The way I see it:

Once you get a company trading below your mos it is only a matter of time until the big shots start seeing it on their radar. Companies selling at such low levels is quite rare. Thus, there is a safety factor against further pain when u get in once you see the momentum picking up.

However, even this can go wrong (look at the CSH posts) and a share can plummet overnight by 25% without any indication.

Thus, you better have a very good idea of how good the jokeys are and whether that horse is worth the bet u wager.

Phil does not teach a magic method nobody knows. Don't ever be fooled believing that. He never meant that at all. It's about basics and fundamentals and he rightfully stresses that you have to be very confident about them in order to sit through any further jitters.

Using the 3 tools gives you a further comfort layer, but that's about it. You gotta be confident about the company on a long term timespan otherwise you get burned.