I was an eager trading upstart with a few trading profits from the dot.com boom way back before the year 2000. It felt I was just one step away from making my fortune. I chucked in my printing business, sold all my printing equipment and researched day and night to find the secret stock charts system to be the next George Soros.
Does this tale sound familiar?
Amazing, in 3 weeks I had found the answer, the STOCHASTIC INDICATOR! For the uninitiated, a stochastic indicator shows the changes in momentum of price and looks something like the waves at the bottom of this chart…
I couldn’t believe how easy this trading thing was. All I had to do was wait for the signals on the stochastic and I could catch the start of an amazing trend! Why hadn’t anyone else seen how much money was available in using the signals to trade pullbacks. The private jet was just around the corner. Maybe I could buy Christopher Skase or Alan Bond’s used one!!!
So after adjusting my stochastic settings to my extra special secret formula (I think I moved the K period to 11), off I went to trade for the big dollars…….
Now the reality did not quite fit the image of me with my laptop by the infinity pool, scotch in hand, watching my account grow. I was watching signals on my large (for the early 2000’s) 15 inch screens, hitting the stochastic cross and then finding the momentum did not magically move up like it should. Sometimes it would move lower, sometimes it would chop and every now and then it would move higher. Many times as I moved to a profit I would move my stop to break-even and then get stopped out. Eventually after a few losses I would take off the stop altogether and bail for a large loss just before a reversal where the market would shoot up.
We’re now in 2019 and I look at markets much differently to back then. Market structure and reading price action are what I focus on in my trading and how I teach students. My view is that trading using stochastic s or any other indicators in isolation creates fairly random outcomes without an understanding of the bigger picture.
When we look at indicators our eyes often skip the failed trades and lock in on the successful ones. After the fact it is very easy to look back on the stock charts and say I would have exited there or I wouldn’t have taken this trade because of such and such.
Effectively using Stochastic Indicators on Stock Charts
The stochastic indicator can be useful but the key is to avoid using it as your sole evidence for entering a trade (or exiting for that matter). My experience suggests using market structure and price movement as your primary trade decision making and any momentum type indicators such as stochastic s you use as support evidence-only. ( Indicators are generally a derivative of price and/or volume)
Given the need to understand the bigger picture rather than solely relying on indicators, it’s time to move onto part 2 of this series on how to read the market structure and understand price action. Click here for more: Stochastic Indicator Part 2: Stochastics & Market Structure.