Online Trading Concepts

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Stochastic Price Divergences

Stochastics

  1. Stochastics Fast & Slow
  2. Stochastic Potential Buy & Sell Signals
  3. Stochastic Price Divergences

Stochastics might be used by a trader to confirm price trend. In the example below of the Nasdaq 100 ETF (QQQQ), the Stochastic indicator spent most of its time in an overbought area. When Stochastics get stuck in the overbought area, like at the very right of the chart, this might be a sign of a strong bullish run. Signals to sellshort might be ignored by a trader; however, before the signal not to short was given, many losses may have accrued from failed shorting attempts on the left half of the chart.

Stochastic pinned above overbought area

The chart below of Gold futures illustrates Stochastic divergences and confirmations:

Stochastic price divergences

Low #1 to Low #2

The Stochastic Slow confirmed the upward movement of gold futures prices by making a higher low.

High #1 to High #2

Gold futures rallied to make a higher high; however, the Stochastic Slow indicator failed to make a higher high, instead it made a lower high. This divergence coupled with a trendline break in the price of gold may have acted as a strong warning to futures traders that the recent rally had probably ended and any long futures positions might be exited or at least scaled back.

Low #3 to Low #4

Gold prices continued its downward tumble, making a lower low at Low #4. On the other hand, the Stochastic Slow indicator was signaling a higher low. This bullish divergence may have warned traders to exit their shortsells, traders may have interpreted that the price of gold had a strong potential of bottoming.

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