Use weekly stochastic indicators to time the market

The buying and selling cycle reveals the hidden intentions of the largest participants in the market because they participate in macro strategies that influence the direction of prices. Investors and traders can identify these cycles through technical tools that measure the persistence of the push behind these cycles, and can use these metrics to predict when these cycles will change from buying to selling, and vice versa. These natural rhythms have shown their greatest power in the major indexes and futures contracts that guide thousands of basic stocks, bonds and foreign exchange crosses.

The S&P 500, Nasdaq 100, and Russell 2000 indexes serve a broad basket of stocks, using easy-to-observe cycles to tell participants what aggressive or defensive measures they need to take when they enter the market.

Popular analysis tools, such as stochastic indicators and Wilders RSI, measure these pulses, usually with amazing accuracy. In turn, investors and traders can use these metrics to determine the timing of entry, exit, and risk management strategies, whether they are focusing on intraday, daily, weekly, or monthly holding periods.

Stochastic indicator

Stock trader George Lane popularized stochastic indicators in the 1950s. This is a seemingly simple formula that compares the current price bar with preset highs and lows. Perhaps due to its simplicity, many 21st-century technicians cannot understand its tremendous power in predicting the cyclical changes of indices and individual tools. This makes it an almost ideal tool to deconstruct the hidden power that drives the modern market. As always, analyzing from multiple directions will produce more reliable results. Stochastics work best when combined with momentum tools such as price patterns, moving averages, and moving average convergence divergence (MACD).

When the cycle reaches its peak and is about to reverse, the stochastic indicator defines overbought and oversold levels. However, we know from experience that the market may be overbought or oversold for a long time. This warning confuses market participants, who are looking for holy grail indicators that can send simple and clear signals in all situations. This natural uncertainty requires specific price and time filters to improve predictability. The two lines created by the indicator are used for this purpose, delaying the verification of the periodic turn until they cross at extreme levels, and then soar towards the midpoint of the analysis grid.

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In particular, the weekly cycle shows the great value of market timing for major instruments and individual positions. When performing macro market analysis, stochastic indicators are almost foolproof, especially when the broad average is pushed to a key support or resistance level and technicians are scrambling to call for a breakthrough or failure to trigger a major reversal.

At these turning points, investors and traders face great stakes when deciding whether to buy in anticipation of a breakout or collapse, or to fade out in the current direction and enter the opposite position to generate profits during the reversal.

Let’s take a look at two weekly random apps that you can use to improve market timing.

Cross and confirmation

Image courtesy of Sabrina Jiang © investingclue 2020

It is the weekend of August and you are reviewing the progress of the market to see if you need to make any adjustments to your sufficient long positions. The S&P 500 index and the Nasdaq 100 index just hit a bull market high, but the Russell 2000 index underperformed and fell into a large trading range. The stochastic indicators of all three instruments have risen to overbought levels.

When the Stochastic indicator rises above the magical overbought line for the first time, there is no need to worry. In fact, when indicators are at extreme levels, the market usually records the strongest gains. However, it now tells you to sit down and watch closely, as a bearish crossover into a new selling cycle lasting 6 to 12 weeks may arrive at any time.

When the Stochastic fast line (blue) crosses the slow line (red) in the first two weeks of September, the next change in technical conditions appears. This will trigger an early warning signal for a new sell cycle, which will remain unconfirmed until the fast line spikes below the overbought level and approaches the midpoint of the analysis grid. This happened quickly after the crossover, confirming the start of a new sales cycle.

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If you trade indexes directly through futures or exchange-traded funds (ETF), you should use these bearish signals to sell long positions or open new short positions. If you hold a stock position, the situation is different, because the impact of an index cycle turn depends on correlation, which represents the trend in which the price direction of a stock matches the most relevant index or indexes. If there is a clear consistency between the trends and patterns of your trading and the price movements of the major indices, your position will show correlation.

For example, most small-cap stocks are closely related to the Russell 2000 cycle turn, which tells us that when held in the opposite direction of the crossover, the risk increases greatly. The same goes for large technology stocks and the Nasdaq 100 index, as well as financial stocks and the S&P 500 index. Bottom line: Cyclical shifts are usually a wake-up call to control risk, whether through exits, stop losses, option protection, or position rebalancing.

Weekly cycle and cross-validation

Image courtesy of Sabrina Jiang © investingclue 2020

No indicator is effective in a vacuum, and the weekly stochastic indicator is no exception. When combined with price patterns, Fibonacci analysis and moving averages, the reliability of the tool increases exponentially. In addition to confirming or refuting the cyclical turn, the auxiliary tool can also determine the specific level of the top and bottom of the print, and predict how far the new impulse to buy or sell will last, and then start to act on the counter impulse.

Google stock hit a record high of more than $600 in early 2014 and was sold off, and the weekly stochastic indicator plummeted from the overbought level. A few weeks later (A) reached an oversold reading, and the price was well above the 50-week exponential moving average (EMA), close to $500. This indicator crossed the buyer in April (B) and became a door nail when the decline continued until early May.

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The stock then rebounded for two consecutive weeks at the 50-week moving average, which is consistent with the 50% Fibonacci retracement line. During the second week of testing the moving average, the fast stochastic indicator (blue) rose above the oversold level, sending a confirmed buy signal, perfectly matching the strong rebound, and increasing by nearly 50 in the next 4 weeks point.

Risks of using weekly stochastic indicators

Finally, let us consider some of the risks of using weekly stochastic indicators for market timing. This indicator can eliminate oscillations that challenge accurate predictions because it can take months without touching overbought or oversold signals. Moreover, even if the cyclical oscillations are perfectly proportional in scale and time, the fast line can still stop halfway and reverse, short-circuiting the reversal strategy and trapping cyclical traders.

Considering this natural complexity, the best defense is to rely on price patterns and other technical tools when the stochastic indicator does not send a strong directional signal. In turn, this indicator provides valuable information about the current state of the market, that it is going through a period of confusion, during which neither bulls nor bears have considerable advantages.

Bottom line

Weekly stochastic indicators reveal repeated buying and selling pressure patterns, and careful investors and traders can predict and use these patterns. The trick is to follow the trend and keep your positioning as consistent as possible with these natural oscillations.

Smart investors will determine their market trends based on the signals sent by the buy/sell cycle pattern, and will use these to predict opportunities for reversals or adjust exposure, but they will also be aware of using other charting tools to adjust their methods Supplemental random analysis is an easier way to ensure accuracy when tracking market trends.

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