Sunday, August 12, 2007

Stochastics

Stochastics generate trading signals before they appear in the price itself. Its concept is based on observations that, as the market gets high, the closing prices tend to approach the daily highs; whereas in a bottoming market, the closing prices tend to draw near the daily lows.

The oscillator consists of two lines called %K and %D. Visualize %K as the plotted instrument, and %D as its moving average.

The formulas for calculating the stochastics are:
%K = [(CCL -L9)I(H9 - L9)] * 100, where
CCL = current closing price
L9 - the lowest low of the past 9 days
H9 - the highest high of the past 9 days

and

%D=(H3/L3~) * 100,
where H3 = the three-day sum of (CCL - L9)
L3 = the three-day sum of (H9 - L9)

The resulting lines are plotted on a 1 to 100 scale, with overbought and oversold warning signals at 70 percent and 30 percent, respectively. The buying (bullish reversal) signals occur under 10 percent, and conversely the selling (bearish reversal) signals come into play above 90 percent after the currency turns. (See Figure 5.40.) In addition to these signals, the oscillator-currency price divergence generates significant signals.



Figure S1. An example of the stochastic

The intersection of the %D and %K lines generates further trading signals. There are two types of intersections between the %D and %K lines:
1. The left crossing, when the %K line crosses prior to the peak of the %D line.
2. The right crossing, when the %K line occurs after the peak of the %D line.

7 comments:

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