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Stochastic
Using the Stochastic method we can compare the
current stock price to its overall price range over
a specified period of time. The theory of the
stochastic indicator is based on the principal that
in an up trending market, stocks tend to close near
their highs & in a downward market stocks tend to
close near their lows.
We use the stochastic indicator to plot two lines on
a chart with the values from 0 to 100. These are the
%D & %K with the %D line being the more significant
of the two. If the readings are above the 80 line
then this signifies that the stock price is nearing
its high & will reverse soon. If the readings are
below 20 then this would mean that its at its lowest
point.

Chart courtesy of
StockCharts.com
In a Ranging market go
long on bullish divergence (on %D) where the first
trough is below the oversold level.
Go long when %K or %D falls below the oversold level
& rises back above it.
Go long when %K crosses above %D
Go short on bearish divergence (on %D) where the
first peak is above the overbought level.
Again go short when %K or %D rises above the
overbought level & then falls back below it
Finally go short when %K crosses below %D
In a trending market the shape of the stochastic
bottom can give you some indication of a rally. If
the bottom of the stochastic indicator is narrow but
not very deep, this indicates that the following
rally should be strong. If the bottom is deep &
broad then this means that the rally should be weak.
We can also apply this to the tops of the stochastic
indicator. If the tops are narrow then this means
that the bulls are weak & that a correction is
likely to follow. If the tops are high & wide then
this indicates that the bulls are strong. Remember
to get the most out of stochastic indicators make
sure you know which market you’re trading in i.e.
Ranging or trending & always use this indicator with
other indicators like Moving Average or
Moving
Convergence etc etc.
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