There are so many indicators available in technical charting that it is sometimes difficult to know which to use. Some traders write off certain indicators such as the stochastics for day trading, simply because it is known as a lagging indicator and therefore they assume it is too slow for their purposes.
Often we are used to seeing stochastics given in examples of trends on daily chart, referring to the price at the close of each day. However, there is nothing to prevent a day trader from simply adjusting the time period to fit with the 15 minute, 5 minute or even the one minute chart.
The stochastic indicator is then just as useful for a day trader as it would be for a trader following long term trends.
Stochastics measure the difference between the last closing price and the price movement over a certain previous number of time periods. You can adjust the number of time periods in your technical charting according to your system, but 14 is the number generally used.
It seems to be a magic number for oscillating indicators, giving a long enough range to be relatively accurate without being so long that it loses relevance for the present moment.
Stochastics can be either fast or slow. This speed does not relate to the number of time periods that it covers, but how quickly it will respond to a change in direction from bullish to bearish or vice versa.
The fast stochastic is more responsive, like a fast car. This is the mathematical formula for fast stochastics:
%K = 100((C – L14)/(H14 – L14))
C= last closing price, L14 = lowest low during the past 14 periods, H14 = highest high during last 14 periods.
There is also a signal line %D which is a 3 period moving average of %K. Stochastic based trading systems usually take a signal from the crossover of the two lines %K and %D.
The fast stochastic was the first and is still the main stochastic indicator used by traders. However, some traders find it responds to changes in price movements too quickly, resulting in a premature signal. Therefore slow stochastics were developed.
The slow stochastic indicator applies a 3 period moving average to the %K of the original equation. The new %D is then a 3 period moving average of the new slow %K. Clearly this is going to reduce sensitivity to minor fluctuations in price.
The slow indicator is therefore the one that is most often used by day traders. It reduces the chance of entering the market on a false signal and also prevents closing out of a trade too soon.
Part of the reason that stochastics are often ignored by day traders is that they focus on the fast stochastic while in fact the slow stochastic would serve them much better. It can be extremely effective, so check it out in your charts or look for a technical charting service that provides it.
