Stochastics!
Make a Good Entry.
Make a Good Exit.

Stochastics is a fine little technical analysis tool when used in conjunction with MACD. By confirming both technical indicators have a bullish reading you’ve added additional probability to your trade.

This indicator tracks the overbuying and overselling of a stock during a short term range. Invented by Dr. George C. Lane, stochastics compares the closing price of a stock to its relative range in the past.

Of course like most technical analysis tools, this is subject to personalized tweaking of the user.

When a stock chart is in a confirmed uptrend the prices will rise and retrace. It's usually because the institutional buyers decide to take some profits on the way up. When other institutions see this, they may start profit-taking as well. Maybe someone knows something they don’t.

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You now have a situation known as “oversold.” The stock was in a strong uptrend. There was no negative information about it. Yet the selling pressure caused a drop in price. Other institutions look at this momentary drop in price as a buying opportunity. After all, the stock was in an uptrend.

Buying ensues and the price rises again. Stochastics identifies the short term reversals and tells us when to enter or exit.

How is this indicator calculated? What's the math behind it? Who cares. Let’s figure out how it makes us money.

The two lines you need to watch are the %K and %D. And no, I don’t know what %K and %D means.

When these two lines are below the 20th percentile as seen on the graph, an oversold situation exists. The impact of selling pressure has brought the price down. We need to watch for the short term turnaround. When the institutions feel the price is temporarily undervalued and its time to buy more.

From mid-September the price was in a slow downtrend and the indicator just seems to wallow at the 20th percentile. At the beginning of October %K crosses over %D and both lines ascend. As does the price of the stock.

Notice the MACD. The histogram starts to put a small bar in a bullish position. At the time of this writing I don’t how this stock will turn out. But I would approach it with cautious optimism.

We can also identify downtrends. Around September 9th our stochastic is in an overbought position. The price is high relative to the short term time frame. Many institutions own it and the general mood is profit taking time. As the sell off occurs, down will come price.

%D crosses over %K at the 80th percentile and heads down. Ladies and gentlemen. We have sell off.

MACD identifies whether a stock is in a trend. Stochastics finds the short term price reversals within that trend. Use stochastics for trading in and out.

%K and %D are represented by different colors depending on what charts you use. For example, Yahoo!, MSN, ClearStation.com have different colored lines. Don't worry. As long as they both go up or down. I’m still waiting for the Board of National Standards to enforce a set of colors.

You can use a slow stochastic or fast. The fast is more sensitive thereby possibly giving off more signals. The increase of signals may include false ones. I use the slow signal. Safe but not sorry.

As always, this is not an exact science. The stock could continue to head up while this indictor is yelling sell. Play it safe.

Don’t drink and drive. And use the MACD in addition.

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