Stochastics

Celticheart Investor

A beginner's guide to trading and investing

Before I move on to other aspects of investing there are a couple more technical trading tools worth exploring.
Some of these are much more suited to the needs of the trader rather than the longer term investor but my view is, the more tools you have available to you the more you can tailor them to your needs, choosing to use any combination that suit both your needs and your investing / trading strategy.

So let's look at the "Stochastic Oscillator" which is fundamentally a technical momentum indicator that compares the closing shareprice to its range over a given period of time. The sensitivity in which this indicator compares movements in the market can be altered by adjusting the time frame or the moving average. In technical terms this oscillator is calculated using the following formula: %K = 100[(C - L14)/(H14 - L14)]

(%D = 3-period moving average of %K)  See: Moving Averages

Where C is the most recent closing sp / L14 being the lowest price paid of the previous 14 sessions and H14 being the highest price paid over the same period. Remember that this time period can be varied according to your needs.

For a more in-depth look at Stochastic oscillators see: Stochastic oscillators

Slow Stochastics will be found at the bottom of your chart. It is made up of two moving averages. The faster moving average is a blue line, the K line, while the slower moving average is the red line, the D line. These two moving averages will move between the 80 line and the 20 line. If the Stochastic is above 80, it said to be “overbought” and if it is below 20 it is said to be “oversold”.

The theory behind this indicator is that in an uptrend prices tend to close near their trading high and conversely close near their trading low during a down trend. Trading signals (buy/sell) occur when the %K crosses through a three day period moving average referred to as %D

The key with using the Stochastic indicator is, as with any indicator, only take signals in the direction of the current dominant trend i.e. if the trend is downward only take sell signals from Stochastics and if the trend is upwards only take buying signals from Stochastics.

Obviously this is a highly technical tool and should, as with all technical analysis  (TA) tools be ideally used in conjunction with other indicators for confirmation and as always without losing sight of the fundamentals of the company.

Next time:  Stop Losses

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.

Reading the Signs

Celticheart Investor

A beginner's guide to trading and investing

Interpreting candlestick charts might seem complex at first but as with all things, the more you understand the easier it gets. There are many elements that can be applied to charting (Stochastics, Bollinger bands often called BBs, Parabolics, Fibonacci numbers and MACD) but for now we will focus only on the candlesticks themselves and look at the others an element at a time. Trying to understand them all at once would only add to the confusion.

To recognise what the candlesticks mean we have to look at the patterns they form. It is by seeing repeating patterns that we come to understand the likely course that trading will follow. Basically all candlestick charts are mapping is sentiment; whether or not the market is positive, negative or neutral and more importantly which way the trend is going to shift.

To start with there are a only a few basic elements you need to worry about, as I mentioned earlier the basic structure of the bar is as shown here on the left with a main body in solid or white and wicks at top and bottom. These are frequently also shown as red and blue or green.

You don't really need to worry about what they are called only to recognise the shapes and the patterns they will form part of in your candlestick chart. It does help to know their names though so that you understand what others are referring to.

So lets look at some basic indicators and what they mean. Candlesticks come in three basic types; Bullish (buyers are dominant), Bearish (Sellers are dominant) and if they are Neutral (Neither buyers nor sellers are dominant).  

If the pattern is bullish then the likelyhood is the share price will either stay as 

it is or rise, if it is bearish then there is a chance the share price will drop and 

of course if it is neutral the price will not change.

The trick is to try and anticipate the change of direction or sentiment before it happens or at least recognise the start of that change. These are some basic patterns that will help you identify that change. 

Some are stronger signals than others but I would always say not to take one signal alone as a certainty, look for conformation signals to back it up.

Below is an example of such a change in direction from earlier today on MAGP showing a shift in sentiment from bearish to bullish.

The chart on the right was based on 1 hour increments but the same principles can apply on a daily, weekly or monthly basis too. The hammer followed by the long red bar was a sign that this share was being oversold and would probably reverse upwards but it was not until two hours later with the doji formed that it was confirmed.

Before we look at more complex patterns it is probably wise to look at simple reversal signals based on as few as 2 or 3 candlesticks. To start with stick to daily chart comparissons although later on you might want to look more frequently on fast moving shares. These are of course just a selection, there are many others to look for.

Below you will see examples of all three types, Bullish, Bearish and Neutral. Some signals are stronger than others but we will come back to that later on. Don't be too focused on the colour as it is not as important as the size of the main body and its relationship with its neighbours.

I have already referred to this book in a previous blog but for me it is an accessible introduction to understanding the basic fundamentals of analysing candlestick charts.

http://www.amazon.co.uk/Candlestick-Charts-introduction-candlestick-char ts/dp/1905641745/ref=sr_1_1?ie=UTF8&qid=1352029161&sr=8-1 

Next time:  How the Candlesticks are formed

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.