by David A. Todd

Traders of stocks who trade on the basis of technical analysis, rather than fundamental analysis, rely on any number of technical indicators to determine the right time to buy and sell stocks. The stochastic oscillator is one of those tools. A double-bottom in the stochastic oscillator seems to indicate investor sentiment has shifted, and more buying has begun.

The Stochastics Double-Bottom Can Form in Different Ways

Figure 1 is a one year chart of Alcoa Aluminum, candlestick style, showing several moving averages, daily volume, and the slow stochastics. The chart has been marked with three points of interest. Area 1 shows a period of almost two months where the stochastic oscillator stayed below the 20 level most of the time, at one point rising to 50 but quickly sinking below 20. A second time it rose above 20 but could not advance. Finally, around March 10 to March 15, the stochastics broke above 20 and continued rising.

Notice the stock price did not make significant rises on the first two rises in the stochastics. A small price rise happened, but with no follow-through. This indicates the beginning of interest in buyers of this stock at these prices. Possibly something was changing in the fundamentals of the stock to cause this interest. Or possibly news related to normal economic cycles had shifted investor interest into this sector or industry, or into this particular stock. In this case, the stock price rose close to one hundred percent over the next four months.

Points 2 and 3 show a double-bottom in the stochastics. Notice that in neither of these cases does the stock price make a double-bottom. However, in both cases the stock price went on a several-week rise of thirty to forty percent.

Stochastics Double-Bottom Not the Only Buying Signal

Figure 2 is a one-year chart of Pfizer Chemicals, with the same indicators shown. Point 1 on this chart marks a double-bottom in the stochastics, again without a double bottom in the stock price. Again, the stock price goes on a solid run of increasing prices lasting several weeks. Point 2 on the chart shows a double-bottom, but a weak one, with the second point of the double-bottom not being below the 20 point. The stock follows with an increase in price, but not as strong as the previous one.

Notice that after this the stochastics do not make another double-bottom, yet the stock price continues on a strong uptrend, punctuated by a few pullbacks. The absence of a stochastics double-bottom did not indicate lack of buying opportunities.

Irregular Double-Bottoms in the Stochastics Can Also Be a Buy Signal

Figure 3 is a one-year chart of IBM, with three points marked. Point 1 shows where the double-bottom did not quite form a typical pattern, yet the stock price rose 25% right after. Point 2 shows a classic stochastic double-bottom, very low on the scale (less than the 10 level), with the stock price having a rapid and dramatic price rise immediately. Point 3 is a double-bottom in the stochastic oscillator, but somewhat weak. The resulting rise in the stock price is not as strong as the previous two.

Studying the stochastic oscillator and how it forms patterns, similar to how a stock price shows patterns, can aid a trader in knowing when to buy a stock.