In the Dugout: Using Stochastic to Enter and Exit Trades

One of the most difficult things to master as a trader is knowing when to enter and exit a trade. Though we don't have a cure-all solution for this, let's talk about one way to help you with this process. The idea is simple, yet very effective, using only an intraday chart and a stochastic oscillator. Unlike most investing sites, our goal is to help you understand the process of trading. Since this is the case, let's first discuss what a stochastic is and how it's used.

The stochastic indicator is often called the stochastic oscillator. This because it is in the form of an oscillator, with the range being between 0 and 100 percent. In general, the indicator shows where the latest closing price is relative to the high and low range over a given number of periods. The idea being that when closing prices are consistently near the top of the price range, it indicates there is buying pressure, with prices closing nearer to the bottom showing selling pressure.

The stochastic is usually drawn with horizontal lines placed at 20 and 80. Two other lines oscillate between 0 and 100. The stochastic indicator can be used for any time frame, but in our case, we are going to use it for a 13-minute intraday chart. The indicator itself will be set to (5,1)5). This is just setting the time frames and smoothing for the stochastic. Any values can be used and should be experimented with, but we have found this setting works good with the 13-minute chart.

"Chart generated by RavenQuote charting software. Copyright (C) 2000 #"

Notice how in the above chart, a move below the 20 line coincided quite frequently with an intermediate low. The opposite also holds true, as a move above the 80 line was quite often the intermediate high. Please note that this is not a way to pick a stock, but a way to decide a more profitable time to enter or exit a security you or interested in buying and selling.

Let's say you have been tracking a stock and you want to buy it if it breaks through its 10-dma. Once this happens, the stock jumps a dollar before you have a chance to place your order. Looking at a chart similar to the above example using the stochastic should help you enter the stock at a better price without chasing it. This is because a security usually does not go up in a straight line. As with any indicator, different securites might be more correlated by using different settings, so experimenting is important.

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