First of all, I'm not a fan of Stochastics. The idea is when stochastics is above 80 or so, it's overbought and we have been taught that we should expect a correction. However one of the most successful trading systems I've back tested only bought overbought stocks and only shorted oversold, the opposite of how the indicator is supposed to work. It worked because stocks can stay at extreme levels of overbought and oversold for a long time.
Stochastics overbought for several months and didn't produce a reliable reversal
However, tonight as I was tinkering, I noticed something interesting, stochastics combined with RSI can give some impressive, somewhat rare, signals.
Here with AAPL, RSI is negatively divergent, AAPL made higher prices, RSI failed to make higher highs and the Stochastics signal called the first top, The RSI divergence continued and stochastics called the second top.
Here in 2007, the first part of the top, ending the uptrend saw a RSI divergence and a good stochastics reversal.
Here on a weekly chart we see the top of the bull market, RSI is clearly divergent and once again, stochastics calls both tops.
It's been sometime since we've seen an RSI divergence as you can see, that is until now and this one is worse then the 2007 divergence.
Here a slight RSI divergence and stochastics turn down calls the Feb. top. Now we see an even worse RSI divergence with stochastics in overbought territory, in fact if you look close enough, it's already crossed over its signal line. It's possible that the combination is calling a major top as this divergence is worse then the 2007 top's divergence.
The example of the first top of 2007 had a divergence of -14.25%, the current divergence in RSI is -22.5%. When use a weekly chart, the 2007 top divergence in RSI was -5% compared to now at -16%
I'm comparing Granny Smith Apples to Pink Lady Apples, but the scarcity of major divergences at major tops forces the comparison. Still, there seems to be something to it.
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