Article The Stochastic Indicator: When it Works, When it Doesn?t & Why

T2W Bot

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Many traders use indicators to determine when to enter and exit trades. Most charting software includes dozens of different indicators that can be displayed on the charts. Popular indicators such as the Stochastic, and MACD, are frequently discussed when traders get together. I have listened to a number of these discussions; the interesting thing is that people typically explain why they use a particular indicator by citing a number of examples of when it has worked for them. When they do, another trader will typically say something like, ‘well it did not work for me, so I use the XYZ indicator which is much more reliable’. When I ask the second trader why his XYZ indicator is more reliable, the explanation usually involves a few more examples of good trades.  
Examples do not prove anything. It is possible to flip a coin and have it come up heads five times in a row. Few traders would observe this and then think that when you flip a coin it always comes up heads. Yet for some...
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the hare

Senior member
2,949 1,283
"The basic Stochastic buy performs dramatically better during bullish market periods"

Well what a surprise. Buy trades taken completely at random exhibit exactly the same thing. An appallingly bad article.
 
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ChocolateDigestive

Experienced member
1,153 281
Re: The Stochastic Indicator: When it Works, When it Doesn’t & Why

"The basic Stochastic buy performs dramatically better during bullish market periods"

Well what a surprise. Buy trades taken completely at random exhibit exactly the same thing. An appallingly bad article.
ha ha ha ha. brightened up my day.
 

the hare

Senior member
2,949 1,283
Re: The Stochastic Indicator: When it Works, When it Doesn’t & Why

With any type of technical analysis, you have to ask the basic question, does this indicator provide an advantage greater than you could expect by random chance.

That advantage could be an improvement in win rate, or an improvement in MFE/MAE etc, and in many cases it might not even result in an improvement in profitability. Using profit as a metric to evaluate the effectiveness of an indicator isnt very smart.

A better approach i to ask the question, how effective is the stochastic at identifying potential turning points, and maybe measure the MAE of trades taken with that particular trigger v random trades held for 5 days. If the entry trigger has merit, the MAE should reduce

Alternatively, you could ask the question can stochatics be used to identify a trend direction, you could use for example the slope of the main or signal line, or %k, or value of stochastic >50 long <50 short or whatever floats yer boat

Although I'm quite critical of the article, I do recommend the approach that he applied regarding exits. If people only grasp the bit I highlighted in bold, they'll have learned something of value.

this isnt the worst article on t2w by a long shot, but maybe t2w should have some form of peer review process prior to publication. I know most people submitting articles are muppet vendors and dont have a clue, but on the odd occasion that something of merit is submitted, a peer review process with feedback would probably have quite a positive impact.

and before anyone asks, no I wouldnt review articles :)
 

rathcoole_exile

Veteren member
3,924 766
Re: The Stochastic Indicator: When it Works, When it Doesn’t & Why

To fans of Stochastics, I always ask
"how is it that one of the most successful Stochastic traders uses it in
exactly the opposite way
to which it is taught to newbies and the masses;
ie, exactly the opposite way to which YOU, Mr OP, are propounding it's use ?"

See Jake Bernstein & Stochastic Pop.

You both can't be right, and my money's on Mr B !!!!!
 

timsk

Legendary member
7,072 1,866
Re: The Stochastic Indicator: When it Works, When it Doesn’t & Why

Although I'm quite critical of the article, I do recommend the approach that he applied regarding exits. If people only grasp the bit I highlighted in bold, they'll have learned something of value.

this isnt the worst article on t2w by a long shot, but maybe t2w should have some form of peer review process prior to publication. I know most people submitting articles are muppet vendors and dont have a clue, but on the odd occasion that something of merit is submitted, a peer review process with feedback would probably have quite a positive impact.
Hi the hare,
I'm pleased you added this post as your first one was very critical without offering anything very constructive for readers less well informed than you. Constructive criticism is warmly welcomed - and here's why . . .

I chose this article, knowing full well that its subject matter would, likely as not, attract criticism. The reason I chose it is that, as you well know, newbie traders are drawn to using indicators like moths to a flame. Most of them don't know how they're constructed, what they are supposed to do and, more importantly, what they're not supposed to do. This article goes a long way towards addressing those issues. Even so, if one takes the view (as some people do) that most (or all) indicators are totally useless, then this article is at best a red herring and certainly won't help newbies trade the markets successfully. Some might even argue that it may actually contribute to their losses. (rathcoole_exile hints at this in his post.) However, the discussion thread is as important as the article itself and provides the perfect platform for members like you to highlight the pitfalls (as you see them) of the article in question. A newbie who takes the time to read both the article and the discussion thread and then evaluates the pros and cons of each argument, will be much better informed (than they were before reading the article) and better placed to decide whether stochastics are worth incorporating into the trading arsenal - or not. For that reason, even if you think the article is 'appallingly bad' - there's still merit in publishing it and much can be learnt from it and the discussion thread.

Lastly, if the peer review process that you advocate had been in place, then there is a good chance the article would have been rejected and then the forum wouldn't have the benefit of your great insights and wisdom!
:p
Tim.
 

Jason101

Experienced member
1,366 214
Re: The Stochastic Indicator: When it Works, When it Doesn’t & Why

Has any one got the code for the XYZ indicator?
 

themilton

Junior member
33 5
New Trader Here

I liked this article. It was pretty informative. However I don't know anyone who would blindly use one indicator and trade off of that alone. Where's the volume? Where's the price action? Where are the trend lines? Especially with no form of risk management, or money management. I'm a new trader and I think the article itself is highly critical of new traders. I did learn something from this article and it will be beneficial to me in the future. But it should be noted that if one does use the stochastic indicator, even without all of the knowledge of back testing and the resources that aren't available to most newbies. One could still be profitable in the markets. By using a wide range of analysis and not blindly using one indicator and holding on to a stock even if the market is telling you otherwise. This article also doesn't take into consideration shorting stocks based on stochastics. If what the author says about going long in bull markets is true, then it should also apply to going short with stochastics in bear markets. This brings me to the old adage cut your loses early and let your winners run. Or something like that. Why would I hold on to a losing trade for five days? I know this was just a test. But the results of the test are skewed because it doesn't take into consideration a number of different factors which has an effect on profitability. The ROI would have been much higher in this article had there been some form of risk management implemeted. Albeit I still get what the author is saying about market conditions. I do believe it is important to know which one you're in and to trade accordingly.
Thank you for the article.
-Milton
 
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DionysusToast

Legendary member
5,963 1,498
Re: The Stochastic Indicator: When it Works, When it Doesn’t & Why

I think we should focus on the Syrup to be honest.
 

the hare

Senior member
2,949 1,283
Re: The Stochastic Indicator: When it Works, When it Doesn’t & Why

You both can't be right
I have to disagree. Lets just start by considering a simplistic argument, with 2 traders applying a mechanical rule based system.

If the maket was trending 100% of the time, the stochastic pop trader would clean up, and the mug punter trying to catch turning points would be fish food.

Conversely, if the market was ranging 100% of the time, the mug punter would clean up, and the stochastic pop trader would be fish food.

The reality is the markets always going to be a chaotic mixture, and both approaches offer opportunities which if managed and exploited correctly could potentially allow both to be profitable. We also need to consider that one mans range is another mans trend. Its entirely possible a trader is applying a stochastic pop approach on a 1 minute chart, and another trader fading the range on a 4 hour chart.

Thats the case with purely mechanical rules, and the moment you allow an element of skill and discretion its a whole new ball game. I would say on balance that the trader using the pop approach does have certain advantages, but the reasons for that are not a suitable topic for discussion here at the zoo.

The other issue of course is there are periods when something as simple as a stochastic pop would have performed very well, and there's always the possibility that a given trader was at the right place at the right time, and there's no doubt that there are specific timeframes in certain markets, during certain periods where fading the stochastic extremes would have performed equally well.

Someone that I work very closely with actually trades the complete inverse rules to me, and if I'm buying, she's usually selling, and yet we both achieve very similar returns :LOL:
 
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rathcoole_exile

Veteren member
3,924 766
Re: The Stochastic Indicator: When it Works, When it Doesn’t & Why

I have to disagree.

Yes mate, I agree with you

I was just trying to be windswept and interesting
in a flawed (but worthy) attempt to juxtapose the presumptions of some that Stochastic trading is an HG
 

ZEN archer

Experienced member
1,528 240
Re: The Stochastic Indicator: When it Works, When it Doesn’t & Why

Great effort from the author - he did quite a research. As I understood the research covered cases of the indicator's crosses back from the oversold/overbought zone.

I found some other ways of using Stochastic better - the way described in the article is widely known and may not be very profitable?
 

Vixdog

Newbie
1 0
Re: The Stochastic Indicator: When it Works, When it Doesn’t & Why

I'm new to this site, but a 30 year trading vet. This is my first post. The first article I read on this site was this one by Palmquist. In my opinion this is a worthy article that describes why newbies get burned. Something I've seen many times from many people. They hear of a great new trading system, look at the results of a given period and put out thousands to join the magical gravy train. Then that magic turns to sorrow when a significant loss makes them doubt their system and then they jump into the next one. I think what Steve correctly conveys here is that you should not trust your money with any system unless you can understand it and have TESTED it in the market conditions you're using in. My impression was that he provided ample proof how to apply simple system testing and how systems do NOT work in all market conditions. Maybe random is better but many people are following systems that will create losses such that he demonstrated. I didn't understand why a previous post would have wanted a peer review and said "appallingly bad article". I completely disagree. Great article!
 

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