Trade Slow Stochastic
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Brought into this world via George C. Lane in the late 1950s, the Stochastic Oscillator is a momentum guide that tells us the position of the current close in relation to the high/low range over a certain number of periods.
George Lane M.D. (1921 to 2004) was a Medical Doctor, stock trader, author, educator, and technical analyst. He created and popularized the Stochastic Oscillator, which is one of the foundational technical indicators used in the present day among technical analysts.
Rumor on the Internet from an interview with Lane, the Stochastic Oscillator doesn't follow price, it doesn't follow volume or anything like that. It follows the speed or the momentum of price. As a rule, the momentum changes direction before price. Thus, the Stochastic Oscillator can be used to identify bullish and bearish divergences to foreshadow reversals.
I have a preference to swing trade the Slow Stochastic because it is more smoothed out than the Fast Stochastic creating fewer head fakes.
A variation between Fast Stochastics and Slow Stochastics is simply a moving average. When working with the Fast Stochastics using the values of 5 and 5, the first 5 is the raw value for Stochastics, while the second 5 is a 5-period moving average of the first 5. When using Slow Stochastics, the first two 5's are the same as with the Fast Stochastics, with the third 5 being a moving average of the second 5. No you are not having an acid flashback, you read that right, a moving average of the moving average. Don't ponder that too much.
This slows the movement of the indicator, consequently the name of Slow Stochastics. By slowing the movement of the indicator down, we will observe fewer signals to buy or sell on the stock chart, although they ought to be more accurate signals to trade for profit.
Like you can see in the illustration above, the Slow Stochastic provides fewer buy and sell signals although they are more correct.
The settings I like to use for the Slow Stochastics depends on the market or stock I am looking at. I always get a chuckle out of traders which try and use a one size fits all tactic. I say use the potential of present day computers and more sophisticated charting tools like Market Club that give a dynamic java interface that lets you scale the settings in real time. Simply take the slider and change the settings so that the signals are smoothed out with less head fakes, and that fits your stock trading style (buy and hold, swing trade, day trade, et cetera).
In addition keep the kind of Stochastic signal you are looking to either buy or sell as fluid as well. For instance, you could find that the signal line breaking above the 20 line is a good buy indicator, whereas a good sell indicator is the signal line breaking below the %D line. You may well uncover that for the market you are in that a cross of the signal line and the %D line is a better buy signal while a good sell signal is at the time the signal line extends above 80 for a day or two and then crosses under the 80 line. You may perhaps uncover that bullish divergences are better trade signals for specific stocks and markets. For instance, go long when the stock price makes a big low but the Stochastic plots a shallower low.
Bear in mind, every stock and market has its own personality at unique times of the year because that personality is a likeness of the communal human psychology of all the investors who are trading that particular market at a particular time of year. Learn to change your Stochastic to the market you are trading and to your own trading style, and watch the money start to flow in.
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