Stocks & Commodities V.

18:8 (30-41): Trading Stochastic Pops by David Steckler

INDICATORS

Trading
Stochastic
Pops
You can identify breakouts using sto-
chastic pops. What are they, anyway?

by David Steckler

any equity traders

strive to identify stocks

M that are ready to break

out and begin a sus-
tained price move up.
The difficulty lies in
identifying which stocks are getting ready
to break out and determining when the
breakout will occur.
One technique I like to use to identify
breakouts is the stochastic pop. The “pop”
comes about when the stochastic indicator
goes above the 70 to 80 level. Instead of
reversing, however, the stock keeps going
and momentum continues to rise. “Sto-
chastic pop” is actually a misnomer, since
the pop is in the price, not the stochastic.
The stochastic itself stays above 70 or 80,
held there by the price moving up and
staying high in its daily ranges.

SETUP CONDITIONS
I identify a stochastic pop setup when the
following conditions occur:
1 Recent price action in a tight daily
consolidation range
2 Daily average directional movement
index (ADX) below 20 (preferably
below 15)
3 Daily stochastic %K above 70 (pref-
erably above 80) and rising
4 Weekly stochastic %K above 50
and rising
5 Stock breakout on above average
MIKE CRESSY

volume, and
6 Bullish market conditions.
Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 18:8 (30-41): Trading Stochastic Pops by David Steckler

THE ADX
The calculation of the average direc- DIRECTIONAL MOVEMENT EXAMPLES
tional movement (ADX) indicator is built
on the intuitive notion that a trend is a
series of price ranges extending in a
consistent direction. In sidebar Figure
A B C D
1, example A, the second day’s trad-
ing range is higher than the first day’s +DM +DM 2
trading range, indicating positive di- 1 1
rectional movement. In example B, 2
the second day’s trading range is be-
2
low the first day’s trading range, an
indication of negative directional move-
1 1
ment. Example C is more complicated because the -DM 2 -DM
second day’s range is both lower and higher than the first
day’s range. Directional movement is only considered to
be up, down or not present. Therefore, the larger part of
the day’s range extending beyond the previous day’s 12
range is used to identify directional movement. In ex-
ample C, the largest part of the second day is higher;
consequently, the directional movement is positive. In
example D, the largest part of the second day’s range is
lower so that the directional movement is negative. In E
example E, the second day’s range is within the first day’s SIDEBAR FIGURE 1: In examples A and C, the directional movement for day 2
range so the directional movement is zero. compared with day 1 is positive because the largest portion of day 2’s range is
Directional movement for the ADX is expressed as a above day 1. In examples B and D, the directional movement for day 2 compared
function of true range (TR). True range is the largest of the with day 1 is negative because the largest portion of day 2’s range is below day 1.
following: In example E, day 2 has zero directional movement compared with day 1.

1 The difference between today’s high and today’s low. A B C D E F G H I J K L M N O P

1
2 The difference between today’s high and yesterday’s 2
Date
920102
High
417.27
Low
411.04
Close
417.26
TR +DM -DM TR14 +DM14 -DM14 +DI14 -DI14 DI DI DX ADX
DIFF SUM
3 920103 419.79 416.16 419.34 3.63 2.52 0.00
close. 4 920106 419.44 416.92 417.96 2.52 0.00 0.00
5 920107 417.96 415.20 417.40 2.76 0.00 1.72
3 The difference between today’s low and yesterday’s 6 920108 420.23 415.02 418.10 5.21 2.27 0.00
7 920109 420.50 415.85 417.61 4.65 0.27 0.00
close. 8 920110 417.62 413.31 415.10 4.31 0.00 2.54
9 920113 415.36 413.54 414.34 1.82 0.00 0.00
1 0 920114 420.44 414.32 420.44 6.12 5.08 0.00
1 1 920115 421.18 418.79 420.77 2.39 0.74 0.00
In the Excel 4.0 spreadsheet (sidebar Figure 2), the first 1 2 920116 420.85 415.37 418.21 5.48 0.00 3.42
1 3 920117 419.45 416.00 418.86 3.45 0.00 0.00
calculation for ADX is the true range value. This is per- 1 4 920120 418.86 415.80 416.36 3.06 0.00 0.20 TR14 +DM14 -DM14 +DI14 -DI14 DI DI DX ADX
1 5 920121 416.39 411.32 412.64 5.07 0.00 4.48 DIFF SUM
formed in column E. The formula for cell E3 is: 1 6 920122 418.13 412.49 418.13 5.64 1.74 0.00 56.11 12.62 12.36 22 22 0 44 0
1 7 920123 419.78 414.36 414.96 5.42 1.65 0.00 57.52 13.37 11.48 23 19 4 42 9
1 8 920124 417.27 414.29 415.48 2.98 0.00 0.07 56.39 12.41 10.73 22 19 3 41 7
1 9 920127 416.84 414.48 414.99 2.36 0.00 0.00 54.72 11.53 9.96 21 18 3 39 7
=MAX(B3-C3,ABS(B3-D2),ABS(C3-D2)) 2 0 920128 416.41 414.54 414.96 1.87 0.00 0.00 52.69 10.70 9.25 20 17 3 37 8
2 1 920129 417.83 409.17 410.34 8.66 0.00 5.37 57.58 9.94 13.96 17 24 7 41 17
2 2 920130 412.17 409.26 411.62 2.91 0.00 0.00 56.38 9.23 12.96 16 22 6 38 15
Next, column F determines the positive directional move- 2 3
2 4
920131
920203
412.63
409.95
408.64
407.45
408.78
409.53
3.99
2.50
0.00
0.00
0.62
1.19
56.34
54.82
8.57
7.96
12.65
12.94
15
14
22
23
7
9
37 18
37 24
2 5
ment or returns zero if there is no positive directional 2 6
920204
920205
413.85
416.17
409.28
413.18
413.85
413.84
4.57
2.99
3.90
2.32
0.00
0.00
55.47
54.50
11.29
12.80
12.02
11.16
20
23
21
20
1
3
41
43
2
6
2 7 920206 414.55 411.93 413.82 2.62 0.00 1.25 53.22 11.88 11.61 22 21 1 43 2
movement. The formula for cell F3 is: 2 8 920207 415.29 408.04 411.09 7.25 0.00 3.89 56.67 11.04 14.67 19 25 6 44 13 10
2 9 920210 413.77 411.07 413.77 2.70 0.00 0.00 55.32 10.25 13.62 18 24 6 42 14 10
3 0 920211 414.38 412.24 413.76 2.14 0.61 0.00 53.51 10.12 12.65 18 23 5 41 12 10
=IF(B3-B2>C2-C3,MAX(B3-B2,0),0) SIDEBAR FIGURE 2: ADX SPREADSHEET. Here is the output for the S&P 500 from
January 1 to February 11, 1992.
Column G calculates the negative directional movement
or returns zero if there is no negative directional move-
ment. The formula for cell G3 is:
=SUM(F3:F16)
=IF(C2-C3>B3-B2,MAX(C2-C3,0),0)
The formula for summing the -DM is in cell J16:
The daily calculations are volatile and so the data needs
to be smoothed. First, sum the last 14 periods for TR, +DM =SUM(G3:G16)
and - DM. The formula for summing the TR is in cell H16:
The smoothing formula for the TR14 column begins at cell
=SUM(E3:E16) H17:

The formula for summing the +DM is in cell I16: =Round((TRUNC((H16-(H16/14)+E17),3),2)

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 18:8 (30-41): Trading Stochastic Pops by David Steckler

The smoothing formula subtracts 1/14th of yesterday’s TR14 original work on the ADX indicator. The next step is to
from yesterday’s TR14 and then adds today’s TR value. The calculate the absolute value of the difference between the
rounding((truncating function is used to calculate the indica- +DI and the -DI. This is done in column M and the formula for
tor as close as possible to the developer of the ADX’s original cell M16:
form of calculation (which was done by hand).
The smoothing formula for the +DM14 column begins at =ABS(K16-L16)
cell I17:
The next column calculates the sum of the +DI and -DI. The
=Round((TRUNC((I16-I16/14)+F17),3),2) formula for cell N16:

The smoothing formula subtracts 1/14th of yesterday’s =K16+L16

+DM14 from yesterday’s +DM14 and then adds today’s
+DM value. The smoothing formula for the -DM14 column The next step is to calculate the DX, which is the ratio of the
begins at cell J17: absolute value of the difference between the +DI and the -
DI divided by the sum of the +DI and the -DI. This is done in
=Round((TRUNC((J16-(J16/14)+G17),3),2) column O. The formula for cell O16:

The smoothing formula subtracts 1/14th of yesterday’s =Round(100*(M16/N16)),0)

-DM14 value from yesterday’s -DM14 and then adds today’s
-DM value. Now we have a 14-day smoothed sum of TR, The final step is smoothing the DX to arrive at the value of
+DM and -DM. The next step is to calculate the ratios of +DM the ADX. First, average the last 14 days of DX values. The
and -DM to TR. The ratios are called the +directional formula for cell P28:
indicator (+DI) and -directional indicator (-DI). The formula
for the +DI column begins at cell K16: =AVERAGE(O15:O28)

=Round((100*(I16/H16)),0) The smoothing process uses yesterday’s ADX value multi-

plied by 13, and then add today’s DX value. Finally, divide
The formula for the +DI column begins at cell L16: this sum by 14. The formula for cell P29:

=Round((100*(J16/H16)),0) =Round((((P28*13)+O29)/14),0)

The INT (integer function) is used because the original —STOCKS & COMMODITIES
developer dropped the values after the decimal in the

The stochastic pop is not new; trader and author Jake congestion — range, the less trending motion it exhibits
Bernstein wrote about this phenomenon years ago. The during the lookback period. Just as a strengthening trend is
setup conditions I added are refinements that increase the measured by an increasing ADX value, a weakening trend is
odds of success by requiring confirming signals from both measured by a decreasing ADX value. My backtesting revealed
the daily ADX and weekly stochastic signals. Keep in mind, that when the ADX falls below 20, and particularly below 15,
of course, that the past performance of this strategy is not an
indication of future success. I utilize this methodology
using daily and weekly charts to trade equities. The less time our money is at risk in the stock
market, the safer our money remains. The
THE ADX INDICATOR stochastic pop technique is yet another tool in
The ADX indicator, developed by George Lane, measures
the strength of a trend. The index uses a scale between zero
our technical arsenal to help achieve these
and 100 to rate the trendiness of a stock or commodity. (See goals, keeping in mind that it may be
sidebar “The ADX indicator.”) considered an aggressive strategy not suitable
The ADX identifies whether the stock or commodity is for all investors or traders.
trending. However, it does not reveal the direction the stock
is trending, only that it is trending: The stronger the trend,
the higher the ADX value. A rising ADX value suggests that the stock has been in a “nontrend” too long and is likely to
the present trend is gaining strength, while a falling ADX break out of its trading range soon and initiate a new trend.
value suggests the present trend is losing strength. A com- I look for stocks that have been “nontrending” too long.
mon interpretation of this indicator is that a stock or com- The longer and narrower the consolidation range, the lower
modity is trending when the ADX passes through 30 and is the stock’s ADX value and the greater the likelihood that
rising. when a breakout does finally come, it will come quickly.
The longer a stock trades in a narrow consolidation — What direction this breakout goes and whether it leads to the
Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 18:8 (30-41): Trading Stochastic Pops by David Steckler

CALCULATING A B C D E F G H I J
STOCHASTICS 1 Date High Low Close Max H Min L Num Den %K %D
2 920817 421.89 419.44 420.74 10 3
The stochastics indicator cal- 3 920818 421.40 419.78 421.34 Period Period
culates the relative level of 4 920819 421.62 418.19 418.19
5 920820 418.85 416.93 418.26
today’s closing price to the 6 920821 420.35 413.58 414.85
trading range selected by the 7 920824 414.85 410.07 410.72
user. Two lines are calculated, 8 920825 411.64 408.30 411.61
%K, which is: 9 920826 413.61 410.53 413.51
1 0 920827 415.83 413.51 413.53
Current Close ± Lowest Lown 1 1 920828 414.95 413.38 414.84 421.89 408.30 6.54 13.59 48.12
%K = 100 1 2 920831 415.29 413.76 414.03 421.62 408.30 5.73 13.32 43.02
Highest Highn ± Lowest Lown 1 3 920901 416.07 413.35 416.07 421.62 408.30 7.77 13.32 58.33 49.81
1 4 920902 418.28 415.31 417.98 420.35 408.30 9.68 12.05 80.33 59.91
This is the raw value of the stochastics indicator. 1 5 920903 420.31 417.49 417.98 420.35 408.30 9.68 12.05 80.33 72.50
The n period is the number of lookback days 1 6 920904 418.62 416.76 417.08 420.31 408.30 8.78 12.01 73.11 77.93
selected by the user, such as 10 days. 1 7 920908 417.18 414.30 414.44 420.31 408.30 6.14 12.01 51.12 68.20
1 8 920909 416.44 414.44 416.36 420.31 410.53 5.83 9.78 59.61 61.39
1 9 920910 420.52 416.34 419.95 420.52 413.35 6.60 7.17 92.05 64.12
3
Σ
j=1
Current Close ± Lowest Lown
2 0 920911 420.58 419.13 419.58
2 1 920914 425.27 419.58 425.27
420.58
425.27
413.35
413.35
6.23
11.92
7.23 86.17
11.92 100.00
77.17
94.03
%D = 100 3
2 2 920915 425.22 419.54 419.77 425.27 413.35 6.42 11.92 53.86 79.08
Σ
j=1
Highest Highn ± Lowest Lown 2 3 920916 422.44 417.77 419.92
2 4 920917 421.43 419.62 419.93
425.27
425.27
414.30
414.30
5.62
5.63
10.97 51.23
10.97 51.32
68.83
52.19
SIDEBAR FIGURE 1: EXCEL SPREADSHEET
%D is a smoothed %K. The above example
smoothes the %K by calculating the ratio of the
summed last three periods of the numerator of
%K to the summed last three periods of the denominator of The denominator for %K is Column H. The formula for cell
%K. H24 is:

In Figure 1, a 10-period %K and a three-period %D are =E24-F24

presented. Column E is the highest high in the last 10 days.
The formula for cell E24 is: %K is calculated in column I. The formula for cell I24 is:

=MAX(B15:B24) =100*(G24/H24)

Column F is the lowest low in the last 10 days. The formula Finally, %D is calculated in column J. The formula for J24 is:
for cell F24 is:
=100*(SUM(G22:G24)/SUM(H22:H24))
=MIN(C15:C24)
The slow version of the stochastics indicator takes these
The numerator for %K is Column G. The formula for cell steps to calculate the value of %D and then relabels %D as
G24 is: slow %K, then smoothes the slow %K with a three-day
moving average for the %D.
=D24-F24 —STOCKS & COMMODITIES

start of a new trend, however, requires the use of additional or oversold condition, or
technical indicators. 3 There exists a divergence between price and stochastic
action.
THE STOCHASTIC INDICATOR While Lundgren watches for %D to rise to the 70 to 80
The stochastic indicator, also developed by Wilder, is a level, my stochastic pop technique calls for the daily %K to
useful oscillating indicator that measures when a stock is rise to the 70 to 80 level.
overbought or oversold. (See sidebar “Calculating Jake Bernstein observed that stocks would continue to rise
stochastics.”) Trader and author David Lundgren identified at times, even after the stochastic reached a level of 70 to 80.
three warnings issued by the stochastic that a trend is likely Key here are the words “at times.” Anticipating that a stock
to change direction: will continue rising merely because the stochastic rose to an
overbought level not only flies in the face of conventional
1 The stochastic %D rises to a level of 70 to 80 (over- analysis (which anticipates a price decline) but also involves
bought) or falls to a level of 20 to 30 (oversold), or a leap of faith that prices will continue rising. How do you
2 The %K–%D cross over each other from an overbought know that this time the stock will continue to rise? For me,
Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 18:8 (30-41): Trading Stochastic Pops by David Steckler

TRADESTATION (OMEGA RESEARCH)

FIGURE 1: SIEBEL SYSTEMS. Just as SEBL breaks out of its consolidation, stochastics go over 70 and prices pop to
twice what they were before.

observing a rising weekly stochastic concurrent with an Figure 1 shows both daily and weekly charts in candle-
overbought daily stochastic reduces some of this FUD factor stick format on Siebel Systems (SEBL). The daily chart is on
(fear, uncertainty, doubt). the left and includes indicators for volume, ADX, and
The logic behind this is well known to technicians: “Trade stochastics; the weekly chart is on the right and includes the
in the direction of the primary trend.” If the weekly trend is stochastic indicator.
bullish and the daily trend is bearish, savvy traders may use On the daily chart, note the area emphasized in the rectan-
pullbacks in the daily price to boost their original position. If gular box and the indicators on those corresponding dates.
the weekly trend is bearish and the daily trend is bullish, SEBL exhibited a congested daily trading range, only one to
traders may use rising prices (particularly if they are on two points wide, between September 27, 1999, and October
declining volume) to enter a short position or exit long 4, 1999 (setup condition 1). As a result, the ADX declined and
positions as they sell into a bear rally. during these few days read between 16 and 18 (setup condi-
Piggybacking a rising (but not overbought) weekly sto- tion 2). At the beginning of this consolidation period, the
chastic on top of an overbought daily stochastic dramatically stochastics were oversold.
increases the odds of a bullish breakout and a stochastic pop On October 5, SEBL broke out of its tight trading range. On
in your favor. that date (see the down arrow), %K had risen to 72.90 (setup
condition 3). Volume was heavy that day at 5.95 million
PUT THE TWO TOGETHER AND WAIT shares, almost twice the 50-day average daily volume of 3.06
A stock with a low ADX value, a rising weekly stochastic, and million shares (setup condition 5).
an overbought daily stochastic is likely to be a breakout On the weekly chart, the preceding Friday’s (October 1,
waiting to happen. I wait for the stock to start trading higher 1999, immediately to the left of the down arrow) %K was at
than the recent congestion-range high. If volume is strong, I 68.35. The stochastic had turned down from an overbought
enter the position on the long side. signal a few weeks earlier and was dropping, but by Friday,

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 18:8 (30-41): Trading Stochastic Pops by David Steckler

FIGURE 2: CISCO SYSTEMS. The logic for daily/weekly combinations also holds with weekly/monthly combinations.

October 8, the stochastic turned upward and the %K closed have what I call the double pop.
the week at 78.47 (setup condition 4). My double pop uses the same six setup conditions as the
An aggressive trader applying the stochastic pop technique stochastic pop, with a slight difference in condition 2:
could have entered a long trade on Tuesday, October 5, the
day SEBL broke out of its consolidation range. This approach 1 Recent weekly price action in a tight daily consolida-
utilizes the intraweek stochastic value. Less aggressive trad- tion range
ers could have waited until the end-of-week weekly stochas- 2 Weekly ADX below 25 (preferably below 20)
tic resumed rising and entered the trade either on the close of
3 Weekly %K above 70 (preferably above 80) and rising
Friday, October 8, or on the open of Monday, October 11.
Figure 1 shows that two weeks later, SEBL was trading 4 Monthly %K above 50 and rising
about 10–15% higher than the entry date choices of October 5 Stock breakout on the weekly chart on above average
5, 8, or 11. Within one month, it had climbed more than 50%. volume
6 Bullish market conditions.
DOUBLE POPS
The stochastic pop is a combination of daily/weekly signals. The double pop uses the same setup conditions as the daily/
If we substitute the daily chart with a weekly chart, and the weekly signals, except that the weekly/monthly setup condi-
weekly chart with a monthly chart, we would have a weekly/ tion 2 uses a weekly ADX value below 25 (preferably below
monthly system that might foreshadow an impending major 20), while the daily/weekly setup condition uses a daily ADX
move. Since this is a longer-term signal, however, the timing value of 20 (preferably below 15).
may not be right for entering a trade. But what happens when Cisco Systems (CSCO) fit this bill in October 1999. Figure
both the daily/weekly and weekly/monthly setups occur 2 shows the daily chart on the left and weekly chart on the
simultaneously? On the rare occasion that this occurs, we right, and Figure 3 shows the weekly chart on the left and

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 18:8 (30-41): Trading Stochastic Pops by David Steckler

FIGURE 3: WEEKLY/MONTHLY. If a breakout occurs on the monthly chart, you should be that much more confident that
the weekly action is sustainable.

monthly chart on the right. expectations, and risk tolerances. Where should an exit be
At the end of October, CSCO was trading in a tight conges- placed when using the stochastic pop technique? That is up to
tion range (setup condition 1) (Figure 2), identified by the the trader. Some may be looking to capture a few points,
rectangular box. The daily ADX on October 28 fell to 14.27 while others may be looking to capture a few dozen. While
(setup condition 2) and the %K rose to 74.90 (setup condition the stochastic pop technique often returns a 25% to 50% gain
3). The next day, the weekly %K rose to 66.01 (setup within four to six weeks, no returns are guaranteed. Use an
condition 4) and the stock broke out to a new high on 150% exit strategy and/or money management methodology that
of the 50-day average daily volume (setup condition 5, but works best with your trading style.
not shown in Figure 2). A stochastic pop was born.
The following trading day, the weekly ADX (Figure 3) had
dropped to 22.80 (double pop setup condition 2) and the CONCLUSION
weekly %K had risen to 77.37 (double pop setup condition 3). Whether as traders or investors, our
The monthly %K had risen to 91.47 (double pop setup goals are simple: Keep our money
condition 4). A rare double pop had occurred. CSCO broke out risk-free until the opportunity arrives
of its tight trading range on October 29, 1999, and closed that to strike; strike when we expect stocks
day at 74. On February 11, 2000, CSCO closed at 13015/16, a to move higher within a relatively
77% gain. short period; move money back to the
sidelines when upward momentum
EXIT STRATEGIES slows or reverses; then wait for the
For every trader and investor, there are different investment next opportunity to arise and the cycle
goals and objectives, price or profit targets, time frame to repeat. The less time our money is

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 18:8 (30-41): Trading Stochastic Pops by David Steckler

at risk in the stock market, the safer our money remains. The Technical Analysis of STOCKS & COMMODITIES, Volume
stochastic pop technique is yet another tool in our technical 18: September.
arsenal to help achieve these goals, keeping in mind that it Luisi, Joe [1997]. “The Stochastic Oscillator,” Technical
may be considered an aggressive strategy not suitable for all Analysis of STOCKS & COMMODITIES, Volume 15: De-
investors or traders. cember.
Lundgren, David [1993]. “Stochastic Indicators And Trad-
David Steckler is an affiliate member of the Market Techni- ing,” Technical Analysis of STOCKS & COMMODITIES,
cians Association and has traded stocks and commodities Volume 11: March.
since 1989. In addition to trading, he is an adjunct professor Star, Barbara [1999]. “How The Pros Use Average Direc-
at Lindenwood University, St. Charles, MO, teaching classes tional Index,” Technical Analysis of STOCKS & COM-
in business law, investments, and personal finance. MODITIES, Volume 17: October.
Steckler, David [1999]. “Detecting New Trends Early,”
RELATED REFERENCES, RESOURCES, Technical Analysis of STOCKS & COMMODITIES, Volume
AND READING 17: November.
Bernstein, Jake [1993]. Investor’s Quotient, John Wiley & Wilder, J. Welles [1978]. New Concepts In Technical Trad-
Sons. ing Systems, Trend Research.
Boot, Martin [2000]. “Trend-Following With The ADX,”

Copyright (c) Technical Analysis Inc.