Buying with the Stochastic Indicator and a Buttish Reversal Candlestick Pattern

The stochastic indicator is another very useful indicator for detecting overbought or oversold security conditions. It has two components: the slow and the fast stochastic. When the fast is under the slow, there's a downtrend in place, and when the fast is higher than the slow, there's an uptrend. The slow and fast stochastic indicators oscillate between 0 and 100 and have fairly complex look back periods, much like the RSI. (See "Buying with the RSI and Bullish Reversal Candlestick Patterns" earlier in this chapter for more info on RSI.)

For simplicity's sake I use the 14-period look back, which is a standard level in charting packages. The standard oversold level for a stochastic indicator is 20, and the standard overbought level is 80. For a detailed explanation of the nuts and bolts of the stochastic indicator, flip back to Chapter 11.

You can use the trend reversal signals that stochastic indicators provide in combination with candlestick patterns to pick outstanding entry points for your trades. And you can also utilize stochastic indicators to select exit points — just keep an eye out for when the slow and fast stochastics cross. Allow me to elaborate in the following sections.

Figure 12-4:

Combining the RSI and candlesticks to select an entry and exit on a chart of TXN.

Stochastic Patterns Trading
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