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Worden Discussion Forum » General Discussions » Stock and Market Talk » Lane's Stochastics
Aloha,
I would like to offer some material I got from George Lane when I attended classes at his school, if this is permitted.
George Lane, M.D. :> In 1954, I was fortunate to join Investment Educators as a "gopher". I carried luggage, ran the projector, made charts, and took attendance for the owner, Ralph Dystant, and for the technical "guru,” Roy Larson. When Mr. Larson (who was getting on in years) retired, Mr. Dystant became the guru for the stock market and I took the No. 2 spot teaching commodities.
Mr. Dystant had a heart attack and, for a time, I taught both stocks and commodities. Some 43 members of the Chicago Board of Trade, Chicago Mercantile Exchange, and MidAmerica Commodity Exchange went through our series of basic, intermediate, advanced, and post graduate courses. They were sharp, experienced traders, who took an aggressive approach to their professional training.
When you teach something, you really have to understand how it works. Fortunately for me, I was forced to learn the field of commodities thoroughly just to stay ahead of these students. Ours was the first school to teach a heavy course in Elliott Wave. Our conventions featured such notable speakers of the day as Bolton, Marcheal, Jeff Drew, etc. These were research days: 20-hour days, all calculating done by hand. The staff expanded to five. I shall not mention names, as they are all well-off financially, still trading, and don't wish to be bothered.
In our research, our indicators were running all over the page, so we developed the technique of expressing them as a percentage of 100. We developed %A, found it didn't work. We went on to research and to follow 28 oscillators. As we progressed through the oscillators we were developing, we expressed them as percentages as well; thus: %D, %K, %R. Larry Williams has taken our %R and refined it, improved it, and made it one of the more successful trend methods.
In the sixties, we pioneered using the computer to test our oscillators. At that time, computers were vacuum tube models filling large rooms. My, how our computer has shrunk -- land, oh, how its capabilities have increased!
One of the thrills of my life has been to find out that another of our members has been testing %D with an econometric indicator developed at University of Michigan (where we perfected %D) and has found it to be predictive.
How to Use Lane's Stochastics:
This method is based on the observation that as price decreases, the daily closes tend to accumulate ever closer to their extreme lows of the daily range. Conversely, as price increases, the daily closes tend to accumulate ever closer to the extreme highs of the daily range. This concept also holds if you are working in either a weekly or monthly degree.
In working with %D it is important to remember that there is only ONE valid signal. That signal is a divergence between %D and the stock with which you are working.
All other signals are only guideposts, or warnings that an important signal is near. The following is a brief description of the various types of formations encountered on the %D chart. We have also provided small diagrams of graphic interest to illustrate the significance of each formation.
I. DIVERGENCE. As previously stated, this is the only signal, which will cause you to buy or sell. Briefly stated, when a stock has made a high, then reacts, and subsequently goes to a higher high, while the corresponding peaks on %D make a high then a lower high, a bearish divergence has been indicated. A sell signal is upon you.
Conversely, when a stock has made a low, then rallies and subsequently moves down to a lower low, while the corresponding low points of %D have made a low, and then a higher low, you have a bullish divergence.
The signal to ACT on this divergence comes when the "K" (dash-line) crosses on the right hand side of the peak of the "D" (solid-line) line, in the case of a top; or on the right hand side of the low point of the "D" line in the case of a bottom.
II. TYPES OF CROSSOVER. A right hand cross over is the most desirable.
III. HINGE. A reduction in the velocity of movement in either "K" or "D" indicating a reverse of trend the
next day.
IV. WARNING. When the "K" line has been declining each day and then one day reverses sharply (from 2% - 12%) this is a warning that you have only one or two more days of downward movement before a reversal.
V. "K" REACHING THE EXTREMES OR 0% OR 100%. When the "K" line declines to a value of "0" this does not denote an absolute bottom on the stock. On the contrary, it signifies a pronounced weakness.
IMPORTANT. After "K" initially reaches "0" it will rebound, usually to about 20% - 25% and then come back toward "0". It may not always reach "0" the second time, but should at least come close. (Your experience and observation will indicate closeness to you.) Normally, It will take from 2 days to 5 days for "K" to come back this second time, depending on the velocity of the issue with which you are working.
The importance of it all is that you can DEPEND upon its coming back toward zero. On the second time against "0" you can expect at least a minor rally to start.
The reverse of these rules apply at tops using 100%. As in the case of the low, expect a sell-off or correction after the second attempt at 100% by the "K" line. It must be remembered that 100% does not mean that the stock is as high as it can go, nor does 0% mean that we have reached the culmination of the downward move -- in fact, they mean just the opposite. You will have a reaction or hesitation at that level - - then the resumption of the trend -- of that degree -- which is still in force.
VI. SET-UP. This is another form of divergence. The primary function of this signal is to forewarn of a coming important top or bottom. If a corresponding low is made on a stock and on %D and then a swing to the upside occurs; IF on the sell-off the correction of the stock is normal (in proportion making a higher bottom) but %D falls to new lows exceeding its prior low - a bear divergence set-up is signified.
This means that the next swing up will probably provide an important top. The reverse of this holds true for tops.
VII. FAILURE. When "K" has crossed up through the "D" line and then pulls back a few percentage points the next day, but fails to re-penetrate the "D" line on the downside, we call this a failure - and denotes strength or a continuation of upward progression. The same holds true on the downside.
VIII. DIVERGENCE ON THE "K" LINE ONLY. Many times we observe a divergence on the "K" line only. These divergences will necessarily be a few days apart. Great care must be exercised to match exactly the particular days in question. The significance of this signal is not great, for it merely suggests a minor reaction. If you happen to get this signal in conjunction with a major divergence on the "D" line, you will have an additional aid in timing.
In the below chart, we have what is known as a "Double Bottom" pattern. To an alert trader, this particular pattern makes for an easy profit. It is also one of the safest patterns to trade. Let's dissect what is going on here, step by step.
First, we drew a trendline across the tops as soon as two lower highs were made. Typically, in an established trend, a market will bump up against such a line three or four times before reversing.
Next, we analyze the pattern. Focus on the downswing. In this instance, the price was contracting as it was making its descent. The size of bars on the price chart was smaller than the bars of the previous downswings.
Normally, there will be five "legs" in the downward progression, and then we will see the reversal. It quickly becomes apparent that no new lows are being made at the first leg of the Double Bottom. So, we look for acounter-trend rally --- and we get one! With it, there is a penetration of the trendline. This is a major piece of information!
What comes next is the clincher that tells you that the trend is changing. Price comes back down and touches the trendline, but is unable to make a closing price beneath it.
Since the pattern spells a reversal in trend, we then look to Stochastics to confirm what we think will happen. Stochastics, which was developed here at Investment Educators by our own George Lane, is a momentum oscillator. Its function is to detect changing velocity in trends.
Take a look at the first bottom that the pattern made...the one before the trendline was first penetrated. Look where Stochastics was at the time. Next, look at where the retest of the low was made and observe where Stochastics was at the time of the retest. The second low on Stochastics was higher than the first low on Stochastics, while the price was making equal lows. This is called convergence. Convergence indicates that the momentum has sufficiently changed to predict a reversal in trend. It confirms that the bottom has been made.
On the way up, it quickly becomes apparent that this is a strong, uptrending market. This market is in a hurry to go someplace and we can know this by looking carefully at the size of the "reactions, or "countermoves" that it makes on its way up. They are very small and short-lived. This indicates the aggressiveness of the bulls.
Catching a strong trend like the one shown is what traders live for. They don't come like that every day, so we like to stay in them as long as possible. To accomplish this, there are methods available that will assist us in determining how far a market can go in one direction before correcting again. Elliott Wave is one method that can do this with awe-inspiring accuracy.
We hope you have enjoyed this lesson. Good luck and good trading! George Lane
stochastics,macd, rsi simply mimic price. i quit using those indicators for daytrades.
price, volume and internal breath are more important.
don't think i'd bother with elliot wave in such a short term trade. either, theres not a lot of time for counting waves. just keep a trailing stop at a moving average.
Sumflow, I found your third message very enlightening. I have used Stochastics for some time. I've been favoring Commodity Channel Index, Detrended Price Oscillator and MACD along with Bollinger Bands and finally, (whew) Supply and Demand zones. Stochastics remain an important tool for me. Your explanations were a great read. Thank you.
I've often wondered about the subtle irregularities in them. For example, the usual expectation is the clean oscillation from overbought to oversold. Sometimes they stall midway. Sometimes they show a trendline just as in your third message example. Then there are the deep penetrations and the weak ones. I imagine there is a source that covers these important signals. Perhap you can reference such a source or expand on them?
Steve Bukosky
do people in here actually trade.
QUOTE (funnymony)stochastics,macd, rsi simply mimic price. Try Sto with 5,3,3. New Concepts explains how Stochastics moves before price. Here you can see Sto leads price.QUOTE (funnymony)just keep a trailing stop at a moving average.Try Parabolic for a trailing stop.QUOTE (sbukosky) Sometimes they stall midway.I had one long time user tell me to cover up your chart between 80 and 20 and only use what peaks obove or below. I like it better when they get below 15.
Test Sto on your back history to see how it works with your security. Adjust your charts so they look right. You can see how I have it set up here. But always your signals are from divergence. With Stocks I want to get in just after insiders purchase there own stocks with there own money, and report them on form 4 with the securities and exchange commission. Trade Stochastics only in the direction of trend. Which means after you get into an uptrend you are not looking to get out right away.
MACD is great for pyramiding that next level, but too slow for the initial position because it is a lagging indicaror like all moving averages. Back test MACD against what ever optomized moving averages you are using now and see for yourself.
Back test Wilder's Parabolic against the stops that you are now using. Start the stop under the low day where you should have gotten in, not where you did get in.
The magic indicator and how to use it. all for free. Ah'll be damt.