Stochastic oscillator

The Stochastic Oscillator is another indicator which is useful for trading the most volatile stocks. This strategy utilizes the Stochastic Oscillator on ranging stocks, or stocks which lack a well-defined trend. 

Volatile stocks often settle into a range before deciding which direction to trend next. Since a strong move can create a large negative position quickly, waiting for some confirmation of a reversal is prudent. 

The stochastic Oscillator provides this confirmation. When the price lacks clear direction, and is moving predominantly sideways, sell near the top of the range once the Stochastic moves above 80 and then drops back below. Place a stop just above the high that just formed with a target at 75% of the way down the range. Take long positions near the bottom of the range when the Stochastic drops below 20 and then rallies above it. Place a stop below the recent low and target 75% up the range.

Trades are taken as soon as the price crosses the Stochastic trigger level (80 or 20). Do not wait for the price bar to complete by the time a 1-minute, 2-minute or 5-minute bar completes the price could run too far toward the target to make the trade worthwhile.

The Bottom Line

Volatile stocks are attractive to traders because of the quick profit potential. Trending volatile stocks often provide the greatest profit potential, as there is a directional bias to aid the traders in making decisions. Keltner channels are useful in strong trends because the price often only pulls back to the middle band, providing an entry. The downside is that once the trend ends losing trades will occur. Monitoring price action and making sure the price is making a higher high and higher low before entering an uptrend trade (lower low and lower high for downtrend trade) will help mitigate this defect. 

Volatile stocks don'talways trend they often whip back and forth. During a range when the stochastic reaches an extreme level (80 or 20) and then reverses back the other way it indicates the range is continuing and provides a trading opportunity.