These Little-Known Signals Will Tell You Exactly When to Enter or Exit Your Trades

Dear Reader,

You don’t need a degree in finance to trade options. Anyone can do this.

All that you really need to know is when to jump in and when to get out.

And it’s shockingly easy to do.

The key to making money trading options is timing. Otherwise, you might as well be gambling with your money.

Last week, I showed you how to identify the direction a stock is turning and when it will turn.

Today, I’m going to show you when to enter and exit your options trades.

As you’ll see, there are just six signals you’ll need.

The Six “Signals” That Can Make You Rich

Before I begin, I want to make things a little easier for you. So below is a refresher.

There are two ways to calculate stochastics:

    1) The following formula: %K = 100[C-L of N / H of N – L of N]

%K: (stocks’ current closing price-its lowest low) ÷ (stock’s highest high-its lowest low) x 100

N: the stock

C: the most recent closing price of the stock’s previous trading sessions (remember, a trading session can be a week, a day, or an hour, but the default number of trading sessions is 14)

L of N: the lowest price of the stock’s previous trading sessions

H of N: the highest price of the stock’s previous trading sessions

    2) %D: a 3-session moving average of %K

Now let’s jump into the signals.

    1) The %K crossing above the 20 linethis is a trading signal from the bottom of a stock’ trading range.
    2)The %D crossing above the 20 line: this is a trading signal from the bottom of a stock’ trading range.

Both of these signals indicate that a stock is potentially moving upward in price due to the momentum of the stock coming out of an oversold zone.

A stock is deemed oversold when the stochastic lines are found in the 20 to 0 range.

    3)The %K crossing below the 80 line: This is a trading signal from the top of a stock’ trading range. It tells you when a stock price is moving down.
    4) The %D crossing below the 80 line: This is a trading signal from the top of a stock’ trading range. It tells you when a stock price is moving down.

Both of these signals indicate is that a stock is potentially moving downward in price due to the momentum of the stock coming out of an overbought zone.

A stock is deemed overbought when the stochastic lines are found in the 80 to 100 range.

    5) %K crossing the %D line: this is the more aggressive of the two signals and crosses either the 20 or 80 lines. This typically happens before the before the %D line does so.
    6) %K crossing below the %D line: this is the more conservative of the two signals, as this means that both lines have to exit from either of the extreme zones. This results in a stock that potentially has both lines working for it.

bullishMomentums-mall

bullishMomentum2-small Now keep in mind that you if you use the more conservative option of the two signals, you may lose some of the price move while waiting for both to confirm.

teva-small

slowstochastic-small

Note that the most aggressive of the signals is trading the %K line crossing above or below the %D line.  This will happen prior to the %K or %D crossing above or below the 20 or 80 line

Don’t Make the Same Mistake as Other Traders: Avoid a Double Loss

As I mentioned above and in last week’s lesson, stocks can stay overbought, or in this case, oversold for longer than you’d expect.

It is also possible for this to happen more than once if you are trading this signal crossover. Fluctuating in an oversold zone can cause you to get, what I like to call, whipsawed in and out of trades.

This just means that it’s possible for you to be subjected to a double loss if trying to prematurely recoup a loss through a subsequent short sale of the same security.

So be mindful of this if you would like to use this signal as your trigger for initiating and closing trades.

The %K line crossing above or below the %D line can happen anywhere in the 0 to 100 range. To me, this signal is best used when it happens in an oversold or overbought zone.

This is because a stock has a better chance of moving out of either of these than when the signal occurs in middle of the trading range (where there may be more of an equal balance of bullish and bearish price movements).

Now there may or may not be software programs or other tools are out there that let you scan for these signals. But, as you can see below in the blue square, I have my own proprietary tools that give me the ability to scan for these signals.

ttr-smallI also have the ability to scan for these signals on an individual stock, or I can scan on an endless number of stock lists I that I create myself.

The goal for you is to determine which of the setups you would like to trade, depending on how aggressive or conservative you wish to be on your entry and exits.

I also want to point out that that the develop the developer of Stochastics, George Lane, once said, “stochastics should be used with cycles.” However, I believe that stochastics is more of an accompanying indicator rather than one that should be used exclusively.

Ignoring This Could Mean You Miss a MAJOR Change in Direction

There’s something else that I can’t emphasize enough-

The importance of eyeing positive and negative divergence.

Divergence is when the price of an underlying and the indicator used on it go in opposite directions.

Positive divergence is when the stock creates a new low or trades at a sustained price, and the indicator (or oscillator) doesn’t. Instead, it creates a higher low, or starts to move upward, at the same time.

Negative divergence is when the stock creates a new high or trades at a sustained price, and the indicator (or oscillator) doesn’t.  Instead it, creates a new low, or starts to move downward, at the same time.

As I said when discussing Moving Average Convergence Divergence (MACD) keep an eye out when the indicator you choose to use positively or negatively diverges from price. This could signal a turning point or reversal (a pivot high or pivot low reversal) for that stock.

Let’s take a look at stochastics and the chart below for Teva Pharmaceutical Industries Ltd (NASDAQ:TEVA). These images show the top range in stochastics getting lower while the stock price holds steady at about the same price.

This may be a warning that there the stock price is declining.

One last thing before I go…

Stochastics will signal when a stock is considered oversold and overbought.

Just remember that stocks can stay oversold and overbought.

So to counter this, I advise using stochastics in addition to other strategies.

But get familiar with stochastics by choosing the signal you want to use and look at stock charts over a historical period of time.

See how well the signals worked for a group of stocks.

Here’s Your Trading Lesson Summary:

Last week, I showed you how to use stochastics and pivot points to tell you which direction a stock will turn and when. Now, I’m going to tell you how to use this information to identify the six signals you need to enter and exit your trades perfectly:

  1. %K crossing above the 20 line
  2. %K crossing below the 80 line
  3. %D crossing above the 20 line

And don’t forget to post any questions you may have to the comment board. Later this week, I’ll share these with you.

Until then…

Tom Gentile

6 Responses to “These Little-Known Signals Will Tell You Exactly When to Enter or Exit Your Trades”

  1. If the %K line completes a double top pattern while it’s still above 80 (like it does with Corning stock back in early November ’15), is it worth using that as an early signal? Or should you just wait until the %K breaks below 80?

  2. For the fun of it: If you set the Aroon indicator to 14 days (so it’s tracking the same 14-day lows & highs as the Stochastics indicator), it’s actually pretty good at highlighting divergences between stochastics & price movement. If the Aroon’s Up line is dragging along at around 0 while the Aroon’s Down line is high but moving diagonally downward, then the Stochastics indicator is most likely moving upward (sometimes sharply) while the actual price movement is flat or even down. Likewise, if the Aroon’s Down line is around 0 and the Up line is high but dropping, then most likely the Stochastics indicator is dropping while the price remains (deceptively) firm. However when the two Aroon lines cross each other, this divergent behavior tends to end abruptly!

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