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EDUCATIONAL ARTICLE AT CTCR Online
LOCATION: INDEX >> GUIDE >> A GUIDE TO STOCHASTICS

 

Education Of A Commodity Trader:

Should You Use Stochastics?

Reader comments below!

Should you use stochastics in your trading?

Stochastics are probably the most popular indicator used in futures trading. We have recently issued a special report on stochastics. In it, we interviewed top experts on stochastics, including George Lane. What we found is a sharp diversity of opinion. Some of them thought stochastics are fantastic. George Lane calls it "damn near infallible". Others thought it was pretty much useless.

My own take is that it is a very useful indicator but not in the way that most people use it

Most people believe that they should look to buy a commodity when stochastics dip to below 20 and sell when it goes above 80. In general, you should do exactly the opposite. A move in stochastics to above 80 usually means that the market is trending strongly and should be bought. Take a look at a chart book and check this out. We discuss this in more detail in our special issue.

Also, you can construct profitable trading systems out of stochastics. A simple trend following system can be created out of crossovers of the stochastics line over the 50 level. Buy when it crosses to above 50 and sell when it crosses back below 50.

We tested varying lengths of stochastics to see what kind of profitability we could generate.

The classic length for stochastics is 14. However, we found that using a crossover of the 50 line by the 14 day K line was not profitable.

The good news is that using a K length of anything over 25 was profitable! The highest profitability came from K lines around 40 bars long. However, you also have to add the filter that the price must be higher than five bars previously.

Of course, this simplistic system was often chopped up in sideways markets but made a ton of money when a trend started. However, even the chops were less than most systems and the equity curve was actually quite smooth.

Having said all that, I really don't use stochastics because I find the signals to be too inaccurate. I'm going to do some additional work, based on our interviews, to see if I can create a more robust use for stochastics.

Do you use stochastics? Do you find it useful or dangerous? Send me some email and I will print the best comments on this page.

From Leonardo:

I have been a futures trader for 23 years. I trade for the long term; and have found (statistically) that the 2-3 day breakouts in the direction of the main trend work best when 14 period stoch. is 70% or better, or 30% or lower. The same concept is true in weekly and monthly charts, although there are precious few of them. You could just trade breakouts when you have these extremes and you would be roaringly profitable!

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