Es Emini Day Trading: Meet The Stochastic Indicator
The stochastic indicator is probably one of the most used indicators in most traders arsenal
. Ive read articles where it has been hailed as the greatest indicator ever developed, and some even have referred to it as the ultimate indicator.
Im not ready to bestow greatness on the stochastic indicator, but will concede it is a valuable tool to use when evaluating trades. On its own, it tends to whipshaw traders in and out of trades with little gains or small losses. It is my opinion that its real value is in validating entries and exits from trades.
The Stochastic indicator is far from new, as it has been around since the mid 1950's and was developed by Dr. George Lane. It is a momentum indicator, and it uses support and resistance to calculate the two lines that comprise the indicator. The lines are named %K and %D and its effectiveness is predicated upon the convergence and divergence of the %K and %D lines.
Note: There is also a %Slow-D in the original formulas and some traders still utilize this aspect of the indicator while others have eschewed this section of Lanes original formula.
I will ignore the math used to calculate the formulas due to text related constraints of Internet article writing, but suffice it to say that the Stochastic indicator is purported to be very effective at predicted potential high and lows in market price action. Most traders use the 80 and 20 lines to indicate when a security is overbought or oversold, though it is my opinion that traders should let their trades ride through the overbought and oversold indicators until the stochastic level begins to change directions. My experience has taught me that this is a very effective method to maximize the potential of your trades because most traders to overbuy and oversell much later than traditional overbought and oversold indicators indicate a security is in these areas. Quite simply, buy or selling momentum invariably carries the price straight through the over bought and oversold lines.
The stochastic indicator has three varieties: Fast, Slow, and Full. The basic difference in these indicators in the relative smoothing factor used to calculate the %K and %D lines. As one might expect, the Fast Stochastic exhibits very choppy lines (since they are unsmoothed) and is, in my opinion, less predictable and harder to trade effectively. The Slow Stochastic usually uses a 3 period time frame to smooth the lines so they are more predictable, however, this smoothing tends to cause the slow stochastic to be a bit of a laggard in very active markets. I have found the slow or fast stochastic to be less-than-effective in volatile markets. On the other hand, in highly active markets, there are very few indicators that are of any special value as the market under these conditions is very unstable and tends to not trend in any predictable fashion.
The Full stochastic is probably the most versatile of the three stochastic indicators as it can be manipulated to mimic both the fast and slow indicators. Like most indicators, the trader is required to enter specific time variable to allow calculation of the indicator, for the slow stochastic I often see (14,1,3) as typical variables, though there are such wide range of time variables used by traders with this indicator it is probably not useful to make any suggestions as to which is most effective. Variables such as time period for trading, volatility and holding period all play into what will become the optimum indicator settings for your own personal use.
The most important variable, regardless of time period settings, when using the Stochastic indicator is the convergence and divergence of the %K and %D lines. These lines will give you a great idea as to the momentum on both the up and down side of a trade as to how the market it headed.
I encourage you to experiment with this indicator and get it dialed in to meet your individual trading needs. It can be a great help and provide invaluable information.
by: David S Adams
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