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Chapter 12, Part IV. Stochastic. Part 2

Discussion in 'Complete Trading Education- Forex Military School' started by Sive Morten, Dec 20, 2013.

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  1. Sive Morten

    Sive Morten Special Consultant to the FPA

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    So, here is how it calculates:

    Fast Stochastic:

    %K = 100 [(C-Ln)/(Hn-Ln)],


    C-recent close price;

    Ln – lowest price for last n periods;

    Hn – highest price for last n periods;


    %D = Some MA from %K


    This Stochastic is too choppy, so it’s rarely used in trading. The most common is Slow Stochastic:

    Slow Stochastic:

    It uses as fast line (%K) the %D line of fast stochastic (above):

    %D of fast stochastic = %K of slow stochastic,
    And %D = some MA from %K.


    Hence, Slow Stochastic average initial %K line of fast stochastic twice.

    We will talk only about Slow Stochastic.

    So, any Stochastic has three input values:

    1. Number of periods that used in %K calculation – usually 14 periods as default used;

    2. The period of MA that used for first averaging. Usually 3 periods as default used;

    3. The period of MA that used for second averaging. Usually 3 periods as default used;

    Also, as you can see, I’ve pointed “Some MA”, because there could applied different types of MA for averaging – simple, exponential, smoothed, modified etc. This is depends on trading style and preferences of each trader. Personally, I use Slow Stochastic with (8; 3; 3) parameters and modified way of averaging. You should not think that this is not important – to use simple MA in Stochastic, Exponential, or, say, Smoothed. It IS very important. Because stochastic with same input parameters but with different averaging method will give you different signals. Do you hear me? You will have to spend a lot of time before the computer for estimation which one Stochastic and its parameters are better personally for you. Also, keep in mind that different software has the same indicator name, but could use an absolutely different averaging method. As you understand – you have to investigate first to learn what kind of stochastic in this software is, and only after that apply it.


    And now tell me – why Stochastic couldn’t move beyond 0 and 100?
    Pipruit: Commander, math is not my strong side, you know…​
    Commander in Pips: Don’t worry – just think a bit. I gave you the clue – the answer is in %K calculation…
    Pipruit: Ok, let’s see. The difference between High and Low for n recent periods (Hn-Ln) estimates the trading range of recent n periods. That’s obvious. And the latest close price has to stand in this range – this is also obvious. (C-Ln) – this difference estimates how our close price far from lowest price of last n periods. But this difference couldn’t be more than (Hn-Ln). If Close price C is higher than Hn – then Hn will be automatically equal to C and %K = 100%. Ok, looks like I’ve got it! %K shows in percents how much (C-Ln) range from (Hn-Ln) range. Since Hn and Ln are absolute high and low of recent N periods including our close price, then %K could not be more than 100% or less than zero, because our close price could not be higher than Hn and lower than Ln.​
    Commander in Pips: See – you can do this. But this extremely important conclusion leads to some unwelcome properties of Stochastic. So, let’s pass to discussion of it’s application.
     
    Hamza Samiullah and fran alvarez like this.
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