First, I needed to find a stock that has been trading sideways for the most part on a one-year weekly chart. The Jutia Portfolio provided me with one such candidate: Google (GOOG). Let’s take a closer look.

For this particular graph I used the “Slow Stochastic” indicator that Bigcharts has proved as an option. I was quite surprised to find that this chart of Google fits well in regards to the discussion points I brought up in my previous post on stochastics.

For example, I circled in red all the sell signals that were given when the stochastic crossed below the 80 mark. Also, I circled in green the exact point at which a buy signal was given when the stochastic crossed above 20.

In Part I of my analysis and use of this indicator I also stated that divergences might appear once in a while and can be valuable when spotting the end of a recent trend. The chart above did not disappoint. You’ll notice that I drew a line connecting two descending points on the price of the stock. The mirror image of this occurs when at the same point in time I could connect two ascending points on the stochastic indicator. The rule of thumb in this case would be that when price goes down and the indicator trends up, there is a positive (bullish) divergence and you should be prepared to buy.

This indicator could have helped you buy in near $340 and sold out around $430 in approximately one month’s time.

Seeing that this is a fresh graph of Google, we will look towards the right side of the graph and determine the current status of this stock play. You will notice that the stochastics are indeed above the 80 mark. No bearish divergences have been given yet and the stochastics have not fallen below 80. As long as this scenario holds Google has a fighting chance to break above $500 in the short-term. If Google decides to trend upwards it may render this indicator irrelevant.

Although Stochastics are preferred by some, it is not my indicator of choice. So why would I even discuss it? The reason is for educational purposes and to help you find a strategy that works for you. Who knows, maybe this indicator could be the missing piece in your investment strategy. There are countless strategies that work, but they have to fit your investment style.

Okay…Okay…time to share what I do know about Stochastics.

It is believed that some of the better signals are present when this particular oscillator moves from overbought levels back below 80 (signaling sell) and from oversold levels back above 20 (signaling buy).

Another use is to look for divergences in the similar fashion that we would do with the RSI indicator. By utilizing two key points that trend in the opposite manner as price, we might be able to conclude that the previous trend may soon end.

Note: Stochastics work well in stocks that are drifting sideways in strong trading channels. If the stock you are looking at is in an uptrend or downtrend you may find it difficult to rely on this indicator.

For more information on this topic you can visit StockCharts

In its most basic form, buy and sell signals can be generated by +DI/-DI crosses. A buy signal occurs when +DI moves above -DI and a sell signal when -DI moves above the +DI. Be careful, though; when a security is in a trading range, this system may produce many whipsaws. As with most technical indicators, +DI/-DI crosses should be used in conjunction with other aspects of technical analysis.

ADX combines +DI with -DI and then smoothes the data with a moving average to provide a measurement of trend strength. Because it uses both +DI and -DI, ADX does not offer any indication of trend direction, just strength. Generally, readings above 40 indicate a strong trend and readings below 20 a weak trend. To catch a trend in its early stages, you might look for stocks with ADX advances above 20. Conversely, an ADX decline from above 40 might signal that the current trend is weakening and a trading range may develop.

In the figure below you can see an example of both the MACD and DMI indicators. There is a direct correlation between both indicators telling us that there is a buying point for stock XYZ around $27. A divergence occurs in both indicators as we can see the positive blue line cross above the negative red line. This would be our buy point. A sell point would occur with the positive blue line crossing back underneath the red line.

There are two ways to use the Momentum indicator:

You can use the Momentum indicator as a trend-following oscillator similar to the MACD (this is the method I prefer). Buy when the indicator bottoms and turns up and sell when the indicator peaks and turns down. You may want to plot a short-term (e.g., 9-period) moving average of the indicator to determine when it is bottoming or peaking.

If the Momentum indicator reaches extremely high or low values (relative to its historical values), you should assume a continuation of the current trend. For example, if the Momentum indicator reaches extremely high values and then turns down, you should assume prices will probably go still higher. In either case, only trade after prices confirm the signal generated by the indicator (e.g., if prices peak and turn down, wait for prices to begin to fall before selling).
You can also use the Momentum indicator as a leading indicator. This method assumes that market tops are typically identified by a rapid price increase (when everyone expects prices to go higher) and that market bottoms typically end with rapid price declines (when everyone wants to get out). This is often the case, but it is also a broad generalization.

As a market peaks, the Momentum indicator will climb sharply and then fall off–diverging from the continued upward or sideways movement of the price. Similarly, at a market bottom, Momentum will drop sharply and then begin to climb well ahead of prices. Both of these situations result in divergences between the indicator and prices.

The MACD proves most effective in wide-swinging trading markets. There are three popular ways to use the MACD: crossovers, overbought/oversold, and divergences.

Crossovers: The basic MACD trading rule is to sell when the MACD falls below its signal line. Similarly, a buy signal occurs when the MACD rises above its signal line. It is also popular to buy/sell when the MACD goes above/below zero.

Overbought/Oversold Conditions: The MACD is also useful as an overbought/oversold indicator. When the shorter moving average pulls away dramatically from the longer moving average (i.e., the MACD rises), it is likely that the security price is overextending and will soon return to more realistic levels. MACD overbought and oversold conditions exist vary from security to security.

Divergence: This occurrence indicates that an end to the current trend may be near occurs when the MACD diverges from the security. A bearish divergence occurs when the MACD is making new lows while prices fail to reach new lows. A bullish divergence occurs when the MACD is making new highs while prices fail to reach new highs. Both of these divergences are most significant when they occur at relatively overbought/oversold levels.

Bollinger Bands were created by John Bollinger and are similar to moving average envelopes. The difference between Bollinger Bands and envelopes is that envelopes are plotted at a fixed percentage above and below a moving average, whereas Bollinger Bands are plotted at standard deviation levels above and below a moving average. Since standard deviation is a measure of volatility, the bands are self-adjusting: widening during volatile markets and contracting during calmer periods.

Bollinger Bands are usually displayed on top of security prices, but they can be displayed on an indicator. These comments refer to bands displayed on prices.

As with moving average envelopes, the basic interpretation of Bollinger Bands is that prices tend to stay within the upper- and lower-band. The distinctive characteristic of Bollinger Bands is that the spacing between the bands varies based on the volatility of the prices. During periods of extreme price changes (i.e., high volatility), the bands widen to become more forgiving. During periods of stagnant pricing (i.e., low volatility), the bands narrow to contain prices.

Mr. Bollinger notes the following characteristics of Bollinger Bands:

• Sharp price changes tend to occur after the bands tighten, as volatility lessens
• When prices move outside the bands, a continuation of the current trend is implied
• Bottoms and tops made outside the bands followed by bottoms and tops made inside the bands call for reversals in the trend

A move that originates at one band tends to goal the way to the other band. This observation is useful when projecting price targets.

1. Find the highest prince on the chart. Once this price high has been found, mark it with the letter A.
2. Now move to the momentum indicator for about the same date and mark it accordingly with the letter B. This point can vary by a few days left or right of point A.
3. From this point move to the left on the momentum to find the highest momentum and mark it with the letter C.
4. Now move up to the price that corresponds with C.
5. Mark this point with the letter D. You should now have the configuration as seen in the graph below.
6. Now we can chose the lowest momentum move between letter B and C and mark it with the letter E. This point will become our selling point.

The steps used in finding a divergence are as follows:

1. Find the lowest price low on the chart and mark it with the letter A.
2. Now mark the momentum indicator with the letter B for the same time and date as point A.
3. Mark the previous momentum low with a C.
4. Find the price that corresponds to C and mark it with a D. You should now have a configuration which looks like the following illustration below
5. Now locate the highest point between your point B and C and mark it with an E. This point is our buying point. After the stock trades further past point B do not buy until the momentum breaks past this point E.

The picture is self-explanatory