Stochastic POP Method By Jake Bernstein
George Lane*, a man I have often referred to as “the father of stochastics,” proposed numerous methods for using this important indicator in futures trading. To this day, the stochastic indicator (SI), and its numerous applications is one of the most widely followed, yet still grossly misunderstood and misused indicators in the stock and futures markets. I say “misunderstood and misused” because many traders erroneously believe that because the SI reads high (i.e., 80% or higher) that the given market is priced too high and that a top is imminent. Conversely, they are also under the mistaken impression that a stochastic reading of 20% or lower means that prices are too low and that a bottom is imminent.
I have previously demonstrated that the opposite is, in fact, true---namely, that when stochastics reach 80% or higher, buying is often the right thing to do. I’ve shown that when the stochastics indicator (SI) reaches 20% or lower, selling short is often a profitable procedure. I researched this concept and developed what I termed the “stochastic pop” (SP) method. George Lane was impressed with this approach and adopted it as part of his procedures. He told me that he humorously refers to the SP as the “stochastic poop” when it doesn’t work! Here’s how the SP works: If at the end of the time bar you are using, the 14-period slow, smoothed SI reads 75% or higher, you buy. You hold your position until the %K or %D lines cross in the opposite direction. http://www.lanestochastics.com/index.html A sell signal occurs when the 14-period smoothed SI reads 25% or lower. You hold your short position until %K and %D reverse their relationship. The charts on the following pages show a number of SP signals. Note that the SP signals may be used in all timeframes, however, this depends upon the temperament of the trader. My use of stochastics has, however, changed over the years. Shown below is my improvement on the standard method. I use a 14 period slow stochastic %K with 5 bar smoothing. I do not use %D. I have done considerable trading and research with the SP indicator in historical testing and real time trading. After having done so for many years now, I have developed still another adaptation of stochastics which, although not thoroughly tested as yet, may be even better than the current applications. Here’s how it works. When the stochastic reads above 50%, and then falls below 45%, sell short. Your stop loss is a crossing of the stochastic lines or a move back over the 50% line, which would cause you to reverse to a long position. The reverse holds true for buy signals. When SI has been below 50% and the raise above 55%, you buy.
Stochastic Pop Rules
Here are my rules for Stochastic Pop: 1. Use a 14 period slow stochastic 5 bar smoothing %K. Do not use %D. 2. When stochastic K goes below 25, sell short. Exit with a trailing stop when K goes back above 25. 3. When stochastic K goes above 75, BUY. Exit on tailing stop or when stochastic K goes below 75.
Conclusions The two “non-traditional” stochastic applications I’ve given you are very promising. You may want to spend a little time studying and developing them to your specific needs. There are many variations on the theme and there are specific methods and procedures that you can build into them for more effectively managing risk in order to maximize overall performance. As you can see, stochastics can be a powerful timing and trading tool, however, it’s important to apply it properly. This is true for all market timing and analysis tools.
Jake Bernstein www.Trade-Futures.com
