Ultimate Algorithmic Trading System

Table 2.3 shows the results of the RSI Failure Swing Algorithm from both the
long and short side utilizing the same profit objective and stop used in the first
RSI test.
42
STOCHASTICS AND AVERAGES AND RSI! OH, MY!
George Lane’s Stochastics—Fast %K: Fast %D: Slow %K: Slow %D
Developed by George C. Lane in the late 1950s, the stochastic oscillator, like the
RSI, is a momentum indicator that shows the location of the close relative to the
high–low range over a set number of periods. Mr. Lane stated in an interview
the following concerning the oscillator: ‘‘It doesn’t follow price, it doesn’t follow
volume or anything like that. It follows the speed or the momentum of price. As a
rule, the momentum changes direction before price.’’ The word stochastic is defined
as a random pattern that may be analyzed statistically but may not be predicted
precisely. An appropriate name, if you ask me. In similar fashion to the RSI,
bullish and bearish divergences in the stochastic oscillator can be used to foreshadow
reversals. In other words, if the stochastic says one thing but the market says another,
then be on the lookout for a market reversal. This is very useful information from
a technician’s point of view but very little for the quant trader looking for a very
precise entry definition. However, because the stochastic oscillator is range bound,
it is also useful for identifying overbought and oversold levels.
Calculation for a 14-day stochastic [FAST]:
1. Going back in time 14 bars, calculate the highest high and lowest low prices
during this period.
2. Subtract the lowest low from the current closing price and divide the difference
by the range between the highest high and lowest low. Multiply this quotient by
100 and you will arrive at %K, or fast K.
%K =(C − Lowest low)∕(Highest high − Lowest low) ∗100
3. Fast %D is a simple three-period moving average of the fast %K.
If the current close is near the lowest low, then the numerator in the %K formula
will be small and will produce a low stochastic reading. If the close is near the highest
high, then the numerator will be large. A strong %K indicates a strong uptrend,
whereas a weak %K indicates the opposite, a strong downtrend. Both %D and %K
are plotted alongside each other with the %K line acting as a signal or trigger line.
The slow variation of this indicator is simply a further smoothing of the %K and
%D. In the slow framework the fast %D becomes the slow %K and the slow %D
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