Stochastic Momentum Signal Concept

Dean Christians
2021-08-13
Let's review a concept that uses the fast stochastic indicator to identify a reversal from an oversold condition.

In a note on Tuesday, I shared a trading signal that utilizes the 14-day slow stochastic indicator. As a reminder, the stochastic indicator compares the current closing price to a range of prices over a lookback period. One can find the slow and fast stochastic indicator in most charting applications with a standard-setting of 14 days.

Suppose you're interested in learning more about the stochastic indicator. In that case, a simple google search will provide plenty of material.

Today's note aims to share a concept that uses a derivative of the fast stochastic indicator to identify a hypothetical buy signal when a stock, ETF, or Commodity reverses from an oversold condition.

TECHNICAL INDICATOR

The Fast Stochastic indicator with an input length of 49 days is utilized to assess intermediate-term market conditions.

THE CONCEPT

The fast stochastic net change signal identifies when the N-day net change in the fast stochastic surges above a user-defined level after an oversold condition. The model will issue an alert based upon the following conditions.

SIGNAL CRITERIA FOR THE S&P 500 INDEX

1.) If the fast stochastic indicator crosses below the oversold reset input value of 10%, the reset condition is active. The reset condition must occur for a new signal to trigger.

2.) If the fast stochastic 3-day net change crosses above the overbought threshold level of 42%, and the number of days since the fast stochastic was last below the oversold reset level of 10% is less than or equal to 42 days, then buy.

Why do I use a window period for the signal? Because I want to ensure that a signal is associated with a current oversold condition for the underlying security. 

CURRENT DAY CHART

TRADING STATISTICS

The trading statistics in the table below reflect the optimal days-in-trade holding period of 38 days. When I run optimizations for trading signals, I cap the max number of days at 42.

HOW THE SIGNALS PERFORMED

Performance looks good, especially in the first two months. Looking at more recent history, the 1-week timeframe since 1985 is excellent, with a profitability percentage of 88%.

If you wondered how the signal performs on an actively traded index like the Nasdaq 100 or QQQ ETF, let's take a look

HOW THE SIGNALS PERFORMED - NASDAQ 100 

Performance looks solid across all timeframes, especially in the 1-2 month window.

NASDAQ 100 CHART PERSPECTIVE

The model handled the 2000-02 bear market well. The 3-day net change did not surge above the user-defined threshold level until October 2002.

CURRENT ENVIRONMENT

Trading signals for the fast stochastic net change reversal concept have been absent, with only a handful of oversold conditions. When an oversold condition has developed, the momentum surge requirement is lacking.

Sorry, you don't have access to this report

Upgrade your subscription plan to get access