Technical Indicators: S (part 2)
Stochastic Momentum Index
The Stochastic Momentum Index was developed by William Blau as introduced in the in the January 1993 issue of Technical Analysis of Stocks & Commodities. While similar to the Stochastic Oscillator, the SMI displays where the close is relative to the midpoint of the recent high/low range, as compared to the close relative to the recent high/low with the Stochastic Oscillator. This results is an oscillator that ranges between -100 and +100 and can be a bit less erratic than an equal period Stochastic Oscillator.
The oscillator is comprised of two lines, the SMI (blue) and the moving average of the SMI (red). When the close is greater than the midpoint of the range, the SMI will be positive. When the close is less than the midpoint of the range, it will be negative. The interpretation of the SMI is virtually identical to that of the Stochastic Oscillator. The most basic pattern to trade from is to buy when the SMI falls below -40 and then returns above it. Sell when the SMI rises above +40 and then falls back below that level. Another trading signal is buy when the SMI rises above the moving average, and sell when the SMI falls below the moving average.
As always, before basing any trades on strict overbought / oversold levels it is recommended that one first qualify the trendiness of the market using an indicator such as R-Squared. If indicators suggest a non-trending market, then trades based on strict overbought/oversold levels should produce the best results.
Stochastic Oscillator
The Stochastic Oscillator compares the closing price of a security to its price range over a given time period. Its displayed by two lines, a main line called %K (drawn in solid blue) and a secondary line (in dotted green) called %D. The %D line is the moving average of the %K.
The Stochastic Oscillator contains four variables:
· %K Periods:
This is the number of time periods used in the stochastic calculation.
· %K Slowing Periods:
This value controls the internal smoothing of %K. A value of 1 is considered a fast stochastic while a value of 3 is considered a slow stochastic.
· %D Periods:
This is the number of time periods used when calculating the moving average of %K.
· %D Method:
The method (Exponential, Simple, Time Series, Triangular, Variable, or Weighted) used to calculate %D
When trading using the Stochastic Oscillator, one method is to buy when either %K or %D falls below 20 and then rises back above that level. Similarlily, sell when the either line rises above 80 and then falls back below. Another pattern to look for when timing trades is buy when the %K line rises above the %D line or sell when the %K line falls below the %D line. Lastly, one should always be on the lookout for diveregnces. For example, if prices are making a series of new highs and the Stochastic Oscillator fails to surpass its previous highs, the indicator typically will provide the clue as to where prices will soon head.
Stochastic RSI
The Stochastic RSI, as the name implies, is an Indicator of an Indicator. While the Stochastic Oscillator monitors relationships between closing prices and the range, the Stochastic RSI monitors the RSI values and their relationship over time.
The Stochastic RSI oscillator is calculated:
[ (Today's RSI - Lowest RSI in %K periods) / (Highest RSI in %K periods - Lowest RSI in %K periods) ] *100
As with the Stochastic Oscillator, the Stochastic RSI is usually accompanied by a second line %D which is an EMA of the Stochastic values. From this point the crossover events can be used to provide entry triggers as well as confirmation to other indicators.
Stochastic, Fast
The Stochastic Oscillator was popularized by George Lane (president of Investment Educators, Inc., Watseka, IL). It is based on the observation that as prices increase, closing prices tend to be closer to the upper end of the price range. In downtrends the closing price tends to be near the lower end of the range.
The Stochastic Oscillator is made up of two lines that oscillate between a vertical scale of 0 to 100. The %K is the main line and it is drawn as a solid line. The second is the %D line and is a moving average of %K. The %D line is drawn as a dotted line.
The Fast Stochastic is the average of the last three %K and a Slow Stochastic is a three day average of the Fast Stochastic. Use as a buy/sell signal generator, buying when fast moves above slow and selling when fast moves below slow. Most traders use the Slow Stochastics because of its more reliable signals.
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Three ways to interpret the Stochastic Oscillator:
Buy when the Oscillator (either %K or %D) falls below 20 and then rises back above that level. Sell when the Oscillator rises above 80 and then falls below that level.
Buy when the %K line rises above the %D line and sell when the %K line falls below the %D line.
Look for divergences - prices making a series of new highs as the Stochastic Oscillator is failing to surpass its previous highs.
Stochastic, Full
The Full Stochastic is a generalization of the Fast Stochastic and the Slow Stochastic and uses three parameters:
As in the Fast and Slow Stochastics, the first parameter is the number of periods used to create the initial %K line and %D is again the number of periods used to create the signal line.
What makes the Full Stochastic unique is its use of a "smoothing factor" for the initial %K line. The %K (full) line plotted is a n-period SMA of the initial %K line (where n is equal to the middle parameter).
The Full Stochastic Oscillator is more advanced and more flexible than the Fast and Slow Stochastic and can even be used to generate them. For example, a (14, 1, 3) Full Stochastic is equivalent to a (14, 3) Fast Stochastic while a (12, 3, 2) Full Stochastic is identical to a (12, 2) Slow Stochastic.
Look for readings below 20 as an oversold signal while readings above 80 act as an overbought signal. However, securities can continue to rise after the Stochastic Oscillator has reached 80 and can continue to fall after it has reached 20. It may be better to wait for the oscillator to move from overbought territory back below 80 or from oversold territory to back above 20 before trading.
Stochastic, Slow
The Slow Stochastic charts the daily stochastic as well as a five-day moving average of a 12-day interval. This smoothing of the Stochastic Oscillator is an attempt to reduce volatility and improve signal accuracy.
As with the other stochastic indicators, the signals to look for are oversold securities with values are less than 20 and overbought when greater than 80.
Stochastics work best in broad trading ranges, or in a mild trend with a slight upward or downward bias. The worst market for normal use of stochastics is a persistent trending market that has only minor corrections. It is possible to trade stochastics in a trend by ignoring the usual overbought and oversold levels and entering the market when the end of a reaction against the trend is signaled by a stochastic crossover from any level.
Swing Index
The Swing Index compares the relationships between the current prices (open, high, low, and close) and the previous period's prices to isolate the "real" price of a security. The Swing Index is primarily used as a component of the Accumulation Swing Index as by itself it generates an erratic plot.
The basic formula for the Swing Index is:
= 50 * [ { Cy - C + 0.5(Cy - Oy) + 0.25(C - O) } / R ] * (K / T)
Where:
C = Today's closing price
L = Today's lowest price
O = Today's opening price
Cy = Yesterday's closing price
Ly = Yesterday's lowest price
Oy = Yesterday's opening price
Hy = Yesterday's highest price
K = The larger of either (Hy - C) or (Ly - C)
R = A variable based on the relationship between today's closing price and yesterday's high and low
T = The limit move value
Step-by-step instructions on calculating the Swing Index can be found in Wilder's book, New Concepts In Technical Trading Systems
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