Module 5: Technical Indicators

Lesson 2: Slow Stochastics

I use the slow stochastics indicators frequently to produce reliable buy and sell signals.

If combined with other trading techniques, or tools, one can create a powerful and consistent winning combination.

You will often hear the indicator referred to as the stochastic oscillator.

This is because it falls within the oscillating category of indicators. They oscillate or zig zag up and down.

There are actually three types of stochastic oscillators:

Fast Stochastics: (not covered in this lesson) The fast stochastics is more sensitive, or reactive, to prices. It swings the wildest.

Slow Stochastics: This version is a bit less reactive to prices and doesn’t have as many fluctuations as the fast version. It’s more stable and reliable.

Full Stochastics: (not covered in this lesson) is a more advanced and more flexible version of the stochastic oscillator.

Recap from Lesson 1 (Technical Indicators):

Technical Indicators (i.e. slow stochastics) don’t guarantee what is going to happen, they merely guide you in preparing for what is likely to happen.

Overbought: A technical condition that occurs when there has been a lot of buying and the price of the stock is considered too high and susceptible to a decline.

Oversold: A technical condition that occurs when there has been a lot of selling and the price of the stock is considered too low and a rally in prices is anticipated.

**Keep in Mind**

The stochastic oscillator will be used to aid you in your trading. Use the indicator to assist you in seeing price action more clearly. Do not treat it as if it’s some magic formula that can spit out winning trades. Remember no matter what indicator you use, price and volume will always win the day.

The above point is worth repeating .

Just remember it for now. All indicators can be very seductive in nature. They seem to work so well when you evaluate how they performed in the past (back testing).

Even as you begin to trade in real time they will seem to work perfectly. It’s very easy to forget that it’s just a formula.

Slow Stochastics

I’ve decided to keep things simple for you. I’m going to leave out the technical definition of the slow stochastics, as well as the formula used to devise the indicator. I’m only going to explain what it does and then show you how to use it.

If you’re interested in the technical definition and the formula, you can do a quick search on the web and you should stumble upon it very easily.

The slow stochastics is a momentum indicator, it indicates whether the market is moving to new highs, new lows, or is just meandering in the middle. It’s also used as an overbought/oversold indicator .

When plotted on a stock chart, it forms two lines that move (oscillate) within a range of 0 and 100. When the lines are above 80 it represents strong upward price movement, and below 20 represents strong downward price movement.

Now read through the next part slowly because it’s where a lot of people get lost.

The two lines that form the slow stochastics indicator are called.

• the %K and
• the %D lines

Depending on what charting software you use the two lines may be plotted differently. Sometimes the %D will be a dotted line while the %K will be a solid line. Other times the %D will be blue, and the %K red.

Honestly it doesn’t matter how they are plotted, the main thing you need to be able to determine is which line is the %K versus the %D .

You should see a legend somewhere on the chart itself. In our example below, you see the legend right above the two stochastics lines .

The %K is the main line, and is the faster moving of the two lines. The %D is a slower moving line and is simply a moving average of the %K line.

If you note in the picture you see two numbers in parenthesis within the slow stochastics legend. The first value (5) represents the number of periods (5 days, 5 weeks, etc.) used to calculate the %K line.

The second value (5) represents the number of periods used in the moving average to form the %D line (5 day, 5 week, etc. simple moving average of the %K line).

Sometimes you will see the values at 14 and 3. Adjusting the numbers changes the up and down swings of the line.

A value of 14, 3 might not generate as many up and down swings of the stochastics lines as the values 5 and 5. You have to find what works for you.

Slow Stochastics

Buy and Sell Signals

The slow stochastics is not very useful in choppy or sideways markets. I only recommend using it in trending markets. Whether the market is trending up or down does not matter, as long as it’s trending.

As noted above the stochastic oscillator forms two lines that move (oscillate) within a range of 0 and 100. Trigger lines are normally drawn on stochastics charts at 80 and 20.

Below 20 indicates that the stock is oversold and above 80 indicates that the stock is overbought.

**New Concept** A trigger is when a market condition that you specify is met. It alerts you to the fact that a potential trade is on the horizon.

The main buy or sell signal is formed when the %K line crosses the %D line. This signal is letting you know that a reversal in price trend is possible, but not guaranteed.

Bullish Signals

If you recall from the option trading strategies lesson, bullish means you think or are trading as if the stock is going to go up.

A bullish signal is formed when:

1. The %K and %D lines drop down to 20 or below (oversold territory) and then turn back up and rise above 20.
2. The trigger is when the %K crosses or breaks through the %D line in an upward direction.

Bearish Signals

Bearish means you think or are trading as if the stock is going to go down.

A bearish signal is formed when:

1. The %K and %D lines rise to 80 or above (overbought territory) and then turn back down and fall below 80.
2. The trigger is when the %K crosses or breaks through the %D line in a downward direction.

Even though you get the signals a stock can continue to rise after the slow stochastics has reached 80 and continue to fall after the slow stochastics has reached 20, so beware.

This is just one of many tools used to help you locate winning trades. I have never used this indicator alone. I recommend using an additional technical indicator to supplement the signals you get from the slow stochastics oscillator.

Module 5: Technical Indicators