## Trend Analysis

MACD/STOCHASTIC COMBINATION

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GENERAL DISCUSSION:

Like most traders new to the Stochastic, I was befuddled for a time by its movement, and dismayed by my initial attempts to use it. Fortunately the equipment I used at that time to display the Stochastic was the CQG TQ20/20™. I say fortunately, because the TQ used a modified type of Stochastic, rather than what was said to be the standard Lane Stochastic. Some time later I learned there were differences in Stochastic formulas. Had I attempted to apply this indicator using a different Stochastic formula than what was programmed in the TQ20/20™, my learning curve would have been much steeper. This is because the indicator would have been much more difficult to apply and interpret.

PROGRAMS, PROGRAMMERS, AND PROBLEMS:

At the risk of having your eyes glaze over from boredom or creating a brain embolism from strain, we're going to digress a bit and discuss some significant issues we, as traders, encounter while attempting to utilize trading tools. The Stochastic, and to a lesser extent the MACD, give us a perfect setting for this discussion. We'll consider the Stochastic first.

George Lane1, the originator of the Stochastics, observed that the closing price within the range of a bar had significance relative to future price development. After considerable

1 George Lane, Investment Educators diligent effort, he derived a formula that quantified this belief. That seems straight forward and simple enough, but in the real world of trading software it's anything but straight forward and simple. There are disturbing variations of Stochastic formulas floating around and specified in reference material. Even talking with George himself who is one of the most knowledgeable, generous, and gentlemanly figures associated with the business, I have not found a simple means of getting from the original formula to what we as traders are faced with using now. So here's how we'll proceed. I will try not to bury you in complex math. There are a variety of equations in Appendix E for the mathematicians and programmers among you. I will also give you the option to skip ahead a few pages to the Preferred Stochastic, if your only interest is in knowing what I use. By doing so you will eliminate going through a somewhat tortured discussion. However, you will miss out on some of the issues we face utilizing trading software to make our trading decisions.

As an outgrowth of George's work came a variety of terms:

Lane Stochastic Raw Stochastic Fast Stochastic Slow Stochastic Modified Stochastic The Stochastic

WILL THE RIGHT STOCHASTIC PLEASE STAND UP:

When traders purchase a graphics package from let's say, Trade-Em-Quick Software Inc., we can see that they have "The Stochastic" available as one of their preprogrammed indicators. Great, we're happy, since that's one of the indicators that we've read about and want to use. But, which Stochastic is "The Stochastic"? If we don't know enough to ask some very pertinent questions to some hopefully informed and responsible sales people, we haven't any idea of what we are really getting! So, let's try to learn something about Stochastics and let's be worldly about software and how it is developed.

LANE (RAW) STOCHASTIC:

As far as I'm concerned, all Stochastics can rightfully be called the Lane Stochastic since they all emanated from George Lane's research. Lane Stochastics, i.e. all of the Stochastics we will discuss, have two lines: a fast moving line %K, and a slow moving line %D. There seems to be some agreement between the different Stochastics formulas for %K of the Fast Stochastic, sometimes referred to as the Raw Stochastic, so we'll start with it and I'll include the equation here.

%K, Fast (Raw)Stochastics:

C is the latest close

Ln is the lowest lowfor the last n days

Hn is the highest high for the last n days

### FIGURE 5-1

The calculation of %D, the slow line, is where a large number of the problems arise. The slow line %D, is a smoothed version of the fast line, but there are a variety of ways of smoothing a line. There's the number of periods we can use to smooth a line, as in a five period Moving Average, or a ten period Moving Average. Then, there's the type of Moving Average we can use. We could use a simple, or an exponential Moving Average for example. Since there are a variety of ways of smoothing a line, there are a variety of different Stochastics.

FAST STOCHASTICS:

If we use the formula in Figure 5-1 for %K and smooth it by using a three period modified Moving Average (MAV), we have the %D line of the Fast Stochastic. In George Lane's Stochastics article2, he used an example from the TQ20/20™, which used this type of smoothing of %K to create the % D line. The TQ was also programmed to use the same type of smoothing to create the Slow Stochastic referred to in Figure 5-3.

%>D (ofthe Fast Stochastic) = 3periodMAV of %K (ofthe Fast Stochastic)

FIGURE 5-2

Some software companies will use other smoothing methods, however, and still call the indicator the Fast Stochastic.

2 George Lane, "Lane's Stochastics," Technical Analysis of Stocks and Commodities, May/June 1984.

SLOW ( PREFERRED) STOCHASTICS:

Slow (Preferred) Stochastics are derived from Fast Stochastics. If we take the %D computed above and rename it to %K, and then smooth this line by using a three period modified Moving Average, we have the new slow, Slow Stochastic line, %D. These two lines make up the indicator called the Slow Stochastic, created by a modified Moving Average smoothing. This is what I use ("Preferred").

%K (of the Slow Stochastic) = %D (of the Fast Stochastic))

%D (ofthe Slow Stochastic) = 3periodMAV of%K (ofthe Slow Stochastic

### FIGURE 5-3

Some software companies will use other smoothing methods, however, and still call the indicator the Slow Stochastic. The formula for the modified Moving Average is shown below. The starting point (MAVt) is calculated identically to that of a simple Moving Average.

MODIFIED MOVING AVERAGE (MAV):3

MAVt is the current modified Moving Average value MA Vt-i is the previous modified Moving Average value Pt is the current price n is the number of periods

### FIGURE 5-4

If a simple Moving Average is used instead of a modified Moving Average to perform the smoothing, you get a Slow Stochastic which is significantly less useful. In fact, I find it useless.

3 P.J. Kaufman, The New Commodity Trading Systems and Methods, (New York: John Wiley & Sons, 1987)

MODIFIED STOCHASTIC:

If we start at the original agreed upon formula for the fast %K (Figure 5-1) and smooth that line by any means whatsoever, we have %K of the modified Stochastic. If we then take that %K line and smooth it by any means whatsoever, and call the result %D, we have the slow line of the modified Stochastic. It is likely you will find other definitions of the Modified Stochastic in reference material or software users manuals.

THE STOCHASTIC:

Display Trade-Em-Quick Software or Aspen Graphics™ or CIS TRADING PACKAGE or TradeStation® on your screen and there you have it, an indicator that is a Stochastic. What it is or how useful it is, is anyone's guess. Without diligent research, I wouldn't hope to define this term as the study it suggests can have such vastly different appearance, applicability and usefulness, depending on how the equations are manipulated in the software of your choice!

THE PREFERRED STOCHASTIC:

This is a new term. It is meant to reflect what / use andfind of benefit:. The equations cited above to produce the Slow Stochastic and the modified Moving Average achieve what I want. Other equations and references relating to the Stochastic are in Appendix E so as not to confuse this issue further.

The last time I looked, my Preferred Stochastic was called the Slow Stochastic in CQG, Inc., Aspen™, and our own CIS TRADING PACKAGE. It was not available in TradeStation® as a preprogrammed indicator, but could be created by inputting the proper equations in so-called "Easy Language™"(Appendix D). MetaStock™ defaults do not produce the Preferred Stochastic. You can change the defaults in MetaStock™ without inputting equations, to create the Preferred Stochastic.

When you study the examples of Stochastics on charts in this book, using the Aspen Graphics™ software, you will see the name Modified Stochastic rather than Slow Stochastic, even though Slow Stochastic is my Preferred Stochastic. Why? When I set up the study initially, I didn't trust that the programmers had computed the Slow Stochastics correctly. I therefore went to the Modified Stochastic study and set up the study myself, to duplicate what I knew were correct inputs. I then compared these values with what I •knew were correct: our own CIS TRADING PACKAGE. After I did that, I compared the specific Modified Stochastic I set up in Aspen with what Aspen called the Slow

Stochastic, and found out their programmers did get it right. When we discuss "The Stochastic" in the body of this book, it will be my Preferred Stochastic.

As trading software evolves, it is likely that the Modified Stochastic will supplant all other forms of Stochastics, since by definition the Modified Stochastic can be adjusted to simulate all others. In that case, to simulate our Preferred Stochastic, the user would input four variables:

1. eight periods for consideration (eight days, eight hours, etc.)

2. three periods of smoothing for the fast line

3. three periods of the smoothing for the slow line

4. modified for the type of Moving Average to accomplish the desired smoothing

As if this level of detail does not complicate things enough, let me tell you about two other aspects you need to watch out for when selecting software packages and trading with the indicators they produce.

MARKET-ALIGNED VS TIME-ALIGNED BARS:

It is much easier to program time-aligned bars but they are not as good as market-aligned bars for analysis. Let's look at bonds as an example. Even though the bond market starts trading at 8:20 AM and ends its actual half hour at 8:50 AM, time-aligned bars would begin this market at 8:00 AM, and end the first bar at 8:30 AM. In this example, the first 1/2 hour (8:00-8:30) will have JO minutes ofactual data in it. The secondhalfhour bar will have only 20 minutes of the first half hour's data in it, and 10 minutes of the second half hour's trading data in it. Another example of time-aligned bars producing "erroneous" high, low, last data, would be an hourly S&P. In this case, an hourly S&P's first bar would contain data from 9:00 AM to 10:00 AM although data is not flowing until 9:30 AM! The second hour starts at 10:00 AM and goes until 11:00 AM, instead of correctly starting at 10:30 AM and going until 11:30 AM. With the high, low, last for these intraday charts being recorded "incorrectly," all studies calculated from them are obviously also incorrect. Don't let complacency put you to sleep on this one. Many traders have used studies generated from time-aligned bars for years, with substandard results. Many of these traders are totally unaware of how these studies are being calculated. I suggest to you that the poor performance of indicators may be the result of the improper basis from which they are calculated, rather than the quality of the indicators, or the trader's understanding of their use!

THE DATA SAMPLE:

The second, and again, not so obvious malady certain graphics packages suffer from, derives from the data sample they select to calculate studies. Let's say you reduce the horizontal (time) axis from 140 to 40 bars. If the studies you are using require in excess of 40 bars to produce accurate values, some vendor programming will be inadequate in that they will calculate only from the sample shown on the screen.. Whether you look at 20, 40 or 400 bars on the screen, good graphics programs will give you the same values on the studies. These values should not depend on the number of days shown on the screen assuming, of course, that you have adequate data available on your hard drive to make the calculations accurate.

Loose talk about "this Stochastic" or "that Oscillator," without researching the formulas that are used to create them or the programming behind the creation of the bars from which they are calculated, can lead to the most disappointing results, with no hint of where the problem lies!

PROGRAMMERS AND UPGRADES:

On the subject of programmers, let's talk about what happens in the real world of software development. Let's assume you're the president of a software company and you're also a trader. You have a very stable piece of software you use daily for trading decisions but...it has a teensy, little bug in it. The number 8 in 1998 shows up a little too far to the right of the screen. You go to your programmers and say, "That's kind of annoying; can you fix it?" "Sure!" is the answer. You get the software back two months later and you find out they fixed the number 8, but they also "fixed" a "problem" one of them noticed in the Stochastic equation. Of course, they didn't tell you about this "fix.

I'd like to establish an industry-wide standard to ensure that when programmers do something and don't tell you about it, they lose a toenail. If you think that's harsh, consider a trade you've been planning for weeks, that should have netted you $20,000, but lost $10,000 instead. Why? Because the calculation of an indicator in your trading plan had been changed without your knowledge or approval. You tell me, as a trader, would you personally like to find the pliers, or would you just smile and say, "Please don't do that again?" If I had my way, there would be a lot of limping going on in trading rooms, at least initially!

The same goes for upgrades. The software company that has produced your trading software says they have this fantastic new thing, this wonderful study in their upgrade you couldn't give a gaseous burp for. You're forced to "upgrade," however, since they're no longer going to support that old software version you're working with . You find out later that in the "upgrade," they screwed up the continuous contract generator, created a bug in the cursor window, and your charts won't print correctly any more! When you tell them about this they say, "Don't worry, there's a new upgrade on the way - for only $195.00."

Besides undocumented changes, so-called upgrades can wreak havoc with your trading plan in other ways. Often, a default setting on files contained in the upgrade can overwrite settings you may have painstakingly inputted. I'll give you one example which may or may not apply to the software you use. Bid and ask prices are routinely reflected on your quote page. Most traders want this feature. Most traders, however, do not -want bid and asked prices charted. If you select the "bid and asked not charted" option and this is overwritten by your upgrade, it may take months before you realize your charts are wrong! Meanwhile your indicators, D-Levels™, your highs, lows and lasts, will all be incorrect. You may even think you're due a fill by looking at your chart, when there was only a bid or offer beyond that price!

If you are new to this game take heed. I've been involved with trading software generation and use for 15 years and these issues are real problems. While I am awed by the talent of programmers, I am equally dismayed by some of their actions and the actions of the managers who direct their efforts. These individuals who may know as much about trading as squirrels do about Fourier analysis, can easily take it upon themselves to "improve" or inadvertently destroy our critical decision-making tools!

Notwithstanding the above, were it not for the incredible talent, persistent, dogged work of programmers, I would not have had an opportunity to develop the way I have as a trader. Without programmers, the Displaced Moving Average research, the Oscillator Predictor™ and the striking advantages of my FibNodes™ program would have remained as unfulfilled dreams. So, recognize that the advantages and costs of utilizing computers and human beings to program them, offer awesome benefits, as well as serious challenges. If you keep in mind that software engineers require the same level of strict management and diligent oversight as traders, the benefits should far outweigh the costs.

### USING THE STOCHASTIC

In the early days, I started out with inputs of 14, 3, 3, but later settled on 8, 3, 3. Many of the initial problems I encountered with this study were solved when I internalized the concept of Trend being dependent on Time Frame. There is absolutely no inconsistency with the five minute Stochastic showing a "buy" while the half hour shows a "sell." The inconsistency, if any, is in the user's mind, by not knowing what Time Frame he is trading in, or lacking the experience to handle the speed of variations inherent in very short term, intraday trading.

In my early days trading futures, I used only the Stochastic to determine intraday Trend in the traditional manner. When the fast line crossed the slow line from below 25, and broke above 25, it signaled an up trend. When the fast line crossed the slow line from above 75, and broke below 75, it signaled a down trend. See Chart 5-1.

STOCHASTIC

CHART 5-1

THE MACD (DEMA) STOCHASTIC COMBINATION:

During the mid 80s, Jake Bernstein and I conducted a seminar together. One of the topics he presented was his Dual Exponential Moving Average (DEMA)/Stochastic combination method. Over the years, Jake taught me many things but this particular technique, altered in a specific way, remains among the most powerful in my trading arsenal. The way Jake taught this method was to use the Stochastic in the traditional manner andfilter it with the

DEMA buy or sell. In other words, the Stochastic and the DEMA had to both be on a buy, or both be on a sell, before a confirmed Trend signal up or down was given. So what was a buy on the DEMA? Better yet what is the DEMA? The DEMA is a derivative of Gerald Appel's MACD4 (Moving Average Convergence Divergence) originally developed by Mr. Appel for analyzing stock trends. The MACD is, as Mr. Appel says, quite simple. You take the difference of two Moving Averages of price and create a Moving Average of that difference. The difference of the original two Moving Averages and the Moving Average of that difference, can be plotted as two lines, one fast and the other slow. The equations are in Appendix E.

MACD

### CHART 5-2

Notice, I've used the same two wavy lines on Chart 5-2 to show the MACD that I used to show the Stochastic in Chart 5-1. All I've done is change the scale, since the MACD (DEMA) oscillates about the zero line, while the Stochastic travels between zero and 100. In our work we will essentially ignore the scale for both indicators and simply observe the penetrations of the wavy lines.

Jake Bernstein took maximum advantage of the MACD by using specific exponential Moving Averages rather than whole number inputs as Gerald Appel did, hence the term DEMA5.

4 Gerald Appel, The Moving Average Convergence-Divergence Trading Method (New York: SignalertCorporation) .

5Jacob Bernstein, Short Term Trading in Futures (Probus Publishing Company, 1987).

MACD OR STOCHASTIC BUY

### CHART 5-3

Like the Stochastic, when the fast line crosses the slow line from below, you get a buy. You get a sell signal when the fast line crosses the slow line from above. As much as I like to tweak things to achieve maximum advantage, I have never found any combination of inputs that matches, much less exceeds, those that Jake developed, i.e. .213, .108, .199. These exponential inputs can be simulated by "period" inputs of 8.3897, 17.5185, 9.0503, if the software you are using is programmed to take "period" inputs and simulate exponential Moving Average smoothing. Among those graphics programs I know of which accurately program this study are CQG, Inc., Aspen Graphics™, TradeStation®, and our own CIS TRADING PACKAGE. I'm sure others do as well, but I have not confirmed that fact.

If you're a "shoot from the hip" type and think I'm getting just a little too particular about these details, that's your prerogative. I must emphasize what I believe is important. It's your option to choose to ignore what you please. I'm not saying you will lose money if you don't follow this precisely. I am saying that you should know what it is that you are doing and not make unwarranted assumptions. Besides, we need lots of "shoot from the hip" types. These traders often provide us with the other side of our trade.

Okay, let's assume we have properly calculated and displayed the Stochastics and MACD studies (I will refer to the DEMA as the MACD from this point forward for clarity). Here's how I use them.

CHART 5-4

### CHART 5-5

For my purposes, the MACD is the more reliable Trend indicator. I have continued to use Jake's numbers, thereby leaving it strong. I have deliberately weakened the Stochastic by inputting 8, 3, 3, rather than the stronger 14, 3, 3, originally used by Jake and many others. Above are Charts 5-4 and 5-5 of the Stochastic and MACD for the daily March

U.S. bond contract. Notice that the Stochastic study has a more ragged appearance than the MACD. The flowing lines of the MACD give us a smooth presentation of Trend. This is what we want! The number of buy and sell signals given by the MACD are infrequent compared to the Stochastic. By displaying these two indicators, one on top of the other, in separate windows, as in Chart 5-6, I can evaluate when to fade (go against) a market and when not to.

10/14 lll/l [ll/lB|12/2 112/16 |199?|l/13 )2/3 |2/18 |3/3 ¡3/11 Dalltj

### CHART 5-6

If both the Stochastic and the MACD are on a buy, the Trend is up. If the weak Stochastic signals a sell, I can buy the dip associated with that sell, as long as the (strong) MACD buy remains intact. Notice the solid up trend shown on the MACD between mid-January and mid-February. We had an excellent buying opportunity against Fibonacci support, as the weak Stochastic went into a sell, then got back in gear to the upside. The same can be said on the sell side for the period from mid-November through mid-December. What is more subtle but nonetheless opportune, is the MACD up trend to the far left of the chart. While casual observation suggests that the Stochastic remained in an up trend, real life trading was just the opposite! Why? During the period from mid-October through the November high, there were many times when the Stochastic signaled unconfirmed sells during the day. We can't see those sells by looking at this chart, because the close of the day is the point at which the (confirmed) indicator is computed and this is what we see on Chart 5-6 when we look back. Traders acting on those unconfirmed intraday signals in real time, however, gave us an opportunity to go long when they sold. We could then take profit at pre-calculated Fibonacci Logical Profit Objectives when the Stochastic went back into the buy mode and their buy stops were hit!

By observing the combination signals on the most frequently used charts, i.e. 5, 30, and 60 minute, daily, weekly, and monthly, we can get a bird's eye view of where the weak players are (Stochastic), as well as the position of the strong players (MACD). My aim is to buy dips (Stochastic sells) at Fibonacci retracement points in an up trend (MACD buy), or to sell rallies (Stochastic buys) at Fibonacci retracement points in a downtrend (MACD sell). In this way, I combine Leading (Fibonacci) and Lagging (MACD/Stochastic) Indicators, in such a way as to "safely" interact with price action. You should also note that the traditional requirement for a Stochastic signal to be at the extremes of 25 or 75 is ignored. Just like the MACD, / require only a crossover of the fast line through the slow line for a signal.

Chart 5-7 shows a five minute S&P in a thrusting down move. It's difficult to see the extent of the thrust, since the bars are confined to only one third of the chart. This was done so I could show you the action of the MACD and Stochastic. Initially, both indicators are signaling a sell. An interim price low is reached and the Stochastic goes into the buy mode. It is bringing in the weak longs and getting rid of the weak shorts. The down trend, as defined by the MACD, remains intact. Observing this type of action will show you how trailing stops set in improper areas give knowledgeable players a perfect opportunity to take away positions from weak players, i.e. to buy a dip or sell a rally in the direction of the prevailing Trend. Chart 5-7 shows how the buy stops are hit, driving the market up to Fibnode resistance. After the up move, the Stochastic gets back in line with the MACD and the market returns to its previous direction, perhaps to new lows. This type of action is repeated again and again in a variety of Time Frame charts. Just be sure you are involved in thrusting markets in order to help avoid possible whipsaws.

### CHART 5-7

In teaching the use of this MACD/Stochastic combination signal, I typically break it up into levels of complexity and teach up to the level possible, depending upon the presentation setting and the experience level of the students. The above explanation involves level 1 (waiting for both indicators to agree before defining a Trend), and level 2 (the concept of fading the weak Stochastic indicator while positioning yourself in the prevailing Trend). Later we will have examples of level 1 & 2 utilization of this technique. Level 3 (anticipating or acting on an unconfirmed signal) will be discussed somewhat, while level 4 involves sliding your Time Frame and is too complex a subject to be adequately covered outside a classroom setting. To give you some idea, however, as in the example above, the half hour Trend would typically be on a sell to further support our Stochastic fade on the five minute chart. There will be more examples after we cover Fibonacci analysis.

Now, let's drop back, and look at this from a different perspective. If you think about this approach and consider the mathematics of the Stochastic, you will see how a market can be made to turn. Consider a large local or, more likely, a group of locals who are short the market. If they can hold prices at a given high for several bars (keep prices from going higher), it will force the (weak) Stochastic to turn south. The weak longs start selling their positions and weak shorts initiate new positions on the sell side. Now the locals (and we) can buy those sell orders. The locals can take their several ticks profit while we can position ourselves for the expected new high, or a move up to a Fibonacci expansion Point. If we tried to buy stop the old highs instead of buying in on the dips, we would be at a point of high market slippage. Upon being filled we would have to suffer through yet another pullback, while the locals who have fed us the sell orders, endeavor to make a profit. If we buy the Stochastic sell and the MACD ends up breaking (giving a sell as well as the Stochastic), we know we're wrong and we take the next rally out. If we are operating on a short term Time Frame and have adequate experience employing this method, it is possible to break even, pick up a few ticks, or perhaps suffer only a few tick loss, even when we are wrong!

CHART 5-8

Let's take a look at a relatively simple example on daily crude oil, Chart 5-8.

We obviously have a thrusting, up trending market as defined by the 3X3. If you played this market primarily from the long side on the way up, you'd have done very well. You would not have gotten into trouble by selling point Tl, or by buying points T2 or T3. You wouldn't have made any of these trades, even though Trend rules learned previously would havejustified such a play. (We will discuss Directional Indicators which overrule Trend in the next chapter. They would have you buying at Tl, and selling at T2 and T3, which are all at near perfect Fibonacci retracement points. Pardon me for digressing, but a quick look ahead is sometimes useful.) Now, back to the point.

CLMB3R 3/3 BIHPLC CM 030300 to 050530 /£>CC I ftrtL/ «

CLMB3R 3/3 BIHPLC CM 030300 to 050530 /£>CC I ftrtL/ «

CHART 5-9

Chart 5-9 is the same daily crude oil chart depicted in Chart 5-8, with the MACD and Stochastic indicators added.

The entire downtrend after the high was contained by the MACD. The rally up to Fibonacci resistance at point T3, supported by the Stochastic, gave us a perfect opportunity to get short.

The same can be said for the up move preceding the high. The up move was almost totally contained by the MACD, while the Stochastic gave us ample opportunities to get long when the market retraced.

FREQUENTLY ASKED QUESTIONS:

Wouldn't it be better to have two strong Trend indicators, instead of one weak, and one strong ?

No. The weak Stochastic shows the hand of the weak players. It can also show the Strength of the market. If the Stochastic gives a sell and there's no discernible movement down in price, watch out for a big move up!

Conservative Carl: Do you wait for the bar (time period) to close before making a determination that the indicator has given a signal?

This question leads us into level 3 understanding. By definition, you want confirmation to be certain of the signal. But, if you wait for confirmation, a significant part of the move may be in place. By waiting, you are paying for insurance you may not need. Just as it is acceptable to anticipate the DMA crossing of price, before the period closed, it is also acceptable to anticipate these Trend signals, prior to the close of the period. Be sure you get confirmation of what you have anticipated by the close, or get out immediately!

I ve always bought when I got a Stochastic buy. How can I now sell?

If you are going to be among the 5% to 15% winners, you will have to be open to applying methods and procedures that are different from those of the masses. If it were as easy to win as following a Stochastic crossover, where would all the losers come from to pay the floor, as well as the off floor winners?

Hyper Hank: So I buy when I get a sell on the Stochastic and sell when I get a buy on the Stochastic, right?

No, you fade the Stochastic in a thrusting market in the context of a Trend, supported by the MACD. You don't simply BUY or SELL. Then you employ methods of entry, covered in CHAPTERS 8, 9, 10, 11 and 13.

Why don't you use the 25/75 barriers before assessing a buy or sell signal on the Stochastic?

Any crossing of the fast line through the slow line is considered a signal because of the unique way I am using the indicator. It may also be useful for you to note that trading experience (not formal computerized research) indicates that stronger signals, on both the MACD and Stochastic, are typically given if there is a greater angle of attack at the point of crossing. See Charts 5-10 A & B. The stronger appearance generally is indicative of markets that are moving and turning, rather than consolidating.

STRONGER WEAKER

Diligent Dan: "In the first example of daily bonds (Chart 5-5), it looked like the MACD barely gave a sell near the end of January and then got right back to the up side. Is there some way we could have avoided being whipped as we saw this action unfold? "

Since this was a daily-based signal, it's likely I would have been whipped as you suggest. It's unlikely I would have wanted to take home a position that was against the MACD. There are, however, ways of avoiding being whipped under similar circumstances. If, for example, the Fibonacci support levels have not been penetrated by price, you could have a trading plan that would accommodate a minor break of the MACD. This would give the MACD an opportunity to correct. I give myself this latitude if the MACD signal is of the weaker variety, as in Chart 5-10B A minor break of the MACD on an intraday chart is also easier to live with than a break on the daily, since you can find out quickly if the position will hold on the anticipated Fibonacci retracement. You may choose not to allow this much discretion in your trading plan, until you gain more experience working with the concept.

SUMMARY:

Let's summarize the high points of our second Trend analysis tool, the MACD/Stochastic combination.

• Both the MACD and Stochastic give Trend signals when the fast line penetrates the slow line. These signals remain intact until another penetration occurs. The signal is confirmed at the close of the period.

•The MACD/Stochastic combination is applicable for all Time Frames we use.

• The values I use for the MACD (DEMA) are .213, .108, .199.

• The values I use for the deliberately weakened Preferred Stochastic are 8, 3, 3.

• To get good results using these indicators, you need to investigate the formulas used to create the studies involved as well as the method of programming the mathematical inputs into these formulas. The graphics software used to display the charts should show market-aligned bars, not time-aligned bars.

• By utilizing a specific weak Stochastic and a specific strong MACD, we are able to make informed judgments about what the weak and strong players are doing. Consequently we can determine how to best interact with price to achieve our goals.

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