Stock Trading Systems And Why They Often Use Stochastics
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Stock Trading Systems And Why They Often Use Stochastics

See why many trading systems us the stochastic indicator

by Bill Poulos on January 22, 2013

Hi everybody, Bill Poulos here about an indicator that many stock trading systems use, including many of my trading systems. Many trading systems often use many different indicators, but the one I’m talking about today is: Stochastics. Now in the financial world, Stochastics represent the seemingly random behavior of assets such as stock, ETF, or forex prices. Which is just a fancy phrase for it measures volatility. And when I say volatility, I don’t mean the bad type that we talked about last time. No matter what your stochastic information is telling you, if you see wild bars appearing and the market is moving in a helter skelter fashion: Stay out! Just wait for it to start trending in a more predictable fashion.

No, what stochastic indicators measure is the every day volatility that stocks, ETFs or forex go though on a regular basis. And it can help us determine if a certain security is moving in a tradable fashion. And what I like to use it for is as a marker for change. Take a look at this chart here:

What those circles represent is where a certain security was overbought or oversold, which let’s us know if we’re in an up or down market. In an upward-trending market, prices tend to close near their high, and during a downward-trending market, prices tend to close near their low.

So at the end of the day, at the very least, you can use the stochastic indicator to help you determine the direction of the market. And that’s what I want you to take away from all of this. Because knowing the direction of the market can make or break a trade.

That’s also why many trading systems use this indicator in their methods… it does a great job at what it was inteded to do. So go ahead, take a look at the stochastics next time you trade and see if it can help you get a better grasp on where the market is going.

 

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Bill Poulos

Bill Poulos has been trading the markets since 1974, and in his 30+ years of trading experience, Bill has developed dozens of trading systems and methods. Connect with us on Google+

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{ 2 comments… read them below or add one }

avatar Kok Poo February 5, 2013 at 8:24 pm

Question:
Using Yahoo graphs I find 2 different stochastics, namely the slow and fast stochastic, and on both of them there are two different colored lines, the dark Stoch %K and the light colored Stoch %D.
Please explain the differences and inform which stochastic should be used.
Are the terms “overbought” and “oversold” related to the stochastics, and which action should be taken in those cases?
Thanks.

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avatar admin February 7, 2013 at 1:43 pm

It all depends on the particular trading method you’re using, but in many of my systems, I recommend using the slow stochastics or using both. As far as colors go, most if not all good charting systems will allow you to chose the color of your indicator so you can make that indicator whatever color you like. Then as far as the terms “overbought” and “Oversold” that is exactly what the stochastics can help you determine.

Good Trading,
Bill Poulos

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