1. The Stochastic Oscillator
The stochastic oscillator is a common technical tool that sends an overbought or oversold message, particularly helpful in a non-trending market. Trading ranges typically have neutral momentum characteristics, so we must turn to an overbought/oversold indicator to aid in identifying low-risk entries and exits. We have found the 12-3-3 stochastics to yield a desirable number of signals, registering an oversold reading (or "buy" signal) when the two lines that comprise the oscillator crossover below 20%, and an overbought reading (or "sell" signal) when they crossover above 80%. The stochastics do not lose validity in a trending environment, but their interpretation becomes more subjective.
2. The MACD Indicator
The MACD indicator sends objective trend-following signals that work best, naturally, in a trending or momentum-driven environment. Using the standard 12-26-9 parameters, a bullish crossover occurs when the signal line crosses above the MACD line in a lagging indication of a turnaround, and vice versa for a bearish crossover. Oftentimes, the stochastics have signaled a turnaround before it is confirmed by the MACD indicator, making them complementary indicators. The best "buy" signals seem to occur when momentum is positive based on the uptrending nature of the MACD indicator, and the stochastics are near oversold levels.
3. Relative Strength Comparative Analysis
Once a directional bias is derived from the stochastics and MACD indicator, relative strength comparative analysis can be used to provide additional confidence. A relative strength comparative line is simply a price-to-price ratio, often applied to a stock relative to a sector or major index (i.e., CELG versus the BTK). The line can be evaluated in the same way as price, using trendlines or simple moving averages. An uptrending relative strength line would add confidence to a bullish bias, suggesting the underlying financial instrument is poised to outperform the index it is being compared to, and vice versa.
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