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Basic Approaches to SI Timing

1.ВрВр Percent K and Percent D Crossover Signals

The SI (stochastic indicator) can be used in either its fast or slow mode. The slow SI mode is a moving average version of the fast SI mode. We recommend using_slow SI, since fast SI oscillates too wildly. One method of SI timing is to use the slow SI for buy and sell signals on crossovers of the percent K and percent D SI lines. This approach is illustrated in Figure 5-1. This application of SI requires a considerable amount of trading, trading which varies directly with the length of the SI indicator. Shorter lengths of SI result in more trades and vice versa. This technique is subject to the same limitations found in virtually all moving average and oscillator applicationsтАФit generates numerous false signals and tends to give back too much in profits.

2.ВрВр 25 Percent and 75 Percent SI Crossovers

Generally speaking an SI reading of 75 percent or higher is considered overbought and a reading of 25 percent or lower is considered oversold.

Because the SI can remain in the overbought (OB) or oversold (OS) area for lengthy periods we advise against sell decisions made simply on the basis of an OB condition or buy decisions made simply on the basis of an OS condition. If you use the SI for the purpose of selling and buying on such extremes, you must wait for the cross to occur from OB back under 75 or for a cross above 25 from OS. This approach to the use of SI requires you to wait for SI to rise to 75 percent or higher and then to fall below 75 percent on a closing basis; when it does you will sell or reverse your long position to short. Wait for SI to fall to 25 percent or lower and then to rise above 25 percent on a closing basis. When it does you will buy or reverse your short position to the long side. This application of SI has good potential for trading in virtually all time frames.

Remember, however, that the SI alone will not tell you where to put your stop or where to take your profit. You must use your other methВэods to do so or you must rely on your own judgment for stop-loss placeВэment. As with any method or system you must be prepared to take your losses when necessary.

Please don't resort to excuses to avoid taking your loss and don't add to losing positions just because the SI is heading in a given direction. The SI is not infallible. I have found, however, that when used in conВэjunction with the other timing signals, SI achieves a greater degree of accuracy while limiting false signals and risk.

I have found the 75/25 approach to be more fruitful than the crossВэover method described in the previous section. The technique is very simple. Figures 5-2 and 5-3 illustrate this approach using 5- and 10-minute data. The 75/25 method may be used in virtually any time frame and will work well in 5-, 10-, or 15-minute charts. It is also applicable to 30-minute data; however, when used on data longer than 20 minutes' duration, it no longer serves the purposes of day traders very well.