The NEO/BTC 1-day chart over the past 9 months proves the reliability of the Stochastic Oscillator used in conjunction with RSI, Here are the simple rules to follow to predict future price movements;
Stochastic Oscillator
The Stochastic Oscillator is made up of 2 lines, %K and %D. I use a slow Stochastic Oscillator with 3 slowing periods for %K and 5 slowing periods for %D. This indicator is a quickly adapting representation of overbought and oversold conditions. It is commonly used in conjunction with bollinger bands for short term trades but when used in conjunction with RSI it can be a great tool to predict market tops and bottoms.
Interpretation:
- Buy as %K or %D goes above 20
- Sell as %K or %D goes below 80
- %K crossover of the %D line could be a leading indicator to the above signals, but often yields a false signal
- Divergence - when a price makes a new high but the oscillator fails to make a new high
Bollinger Bands
Bollinger Bands are made up of a moving average (middle line) and an upper and lower band which are the moving average offset by 2 standard deviations. There are many applicable strategies that are usually tailored to short term trades.
Interpretation:
- Price touching an outer band will move to the middle band
- Price bounces between the upper and middle band confirm a bullish trend
- Price bounces between the lower and middle band confirm a bearish trend
- Sharp price movements usually occur following tight contraction of the bands
- Widening of the outer bands indicates a continuation of the current trend
Relative Strength Index (RSI)
RSI is a price following oscillator that indicates overbought and oversold conditions. A 14-day RSI is the most commonly used and it is calculated using the average upward price change and average downward price change over that time period. RSI is used on a 0-100 scale with a low number being oversold and a high number being overbought.
Interpretation:
RSI is a popular indicator and should be used to show chart formations that are not obvious from the candlestick chart i.e. support and resistance lines, tops and bottoms, divergences and other chart formations. Overbought and Oversold conditions are indicated with an RSI above 70 and below 30. In the above NEO/BTC chart we use RSI to confirm our signals by making sure the RSI is returning from and overbought/oversold condition.
Conclusion:
The above trading tools are designed for trading (not trending) markets, so they often provide false signals in a market that remains in the overbought or oversold positions. For that reason, these signals should be used in conjunction with other trading tools, especially fundamental analysis. Happy Trading!