As the major averages and many of your favorite stocks approached new highs earlier this year, many traders were either making plans for that well deserved vacation or contemplating early retirement. Those that even considered the possibility of a retracement or "correction" were most likely licking their chops in anticipation of the next big buying opportunity. After all, buying dips in the market had proven to be quite a profitable venture. In the past year traders were able to bundle up their buy orders and click away when their favorite issue or index broke through resistance or bounced out of a short-term oversold condition.

Most traders used some kind of system to trigger their buy and sell signals. There are numerous excellent technical systems available for our arsenal; trend-following systems, overbought-oversold indicators, volume studies, divergence, support-resistance, as well as many more. Many traders combine technical analysis with fundamental information to form their plan of attack. It is an attack isn't? After all placing our cash on the line, taking a stance could certainly imply we are going into battle. Well, if we are going to do battle, shouldn't we have a plan? You do have a plan don't you?

The current market environment has more than likely poked holes in or exposed weakness in even some of the most sophisticated systems or "plans". The result? New students and even some with many years of experience have returned to the drawing board, in an attempt to repair or replace their system of choice. Some will change the time frame of various studies to have either kicked them out of trades sooner or perhaps not sent them into battle at all. Day-traders, swing traders, or those that position trade will undoubtedly spend countless hours burning the midnight oil attempting to revise their plan. It's the nature of the beast, to fine-tune a system to improve our odds. We are in no way suggesting that traders are wasting their time in making adjustments, back testing, and adjusting their favorite indicators.

It's extremely disheartening to see what appears to be the "perfect" technical setup and entry turn in to a failed rally, not to mention the loss of capital as your account balance begins to disappears right before your very eyes. Even well disciplined veterans can begin to scratch their head after suffering a larger than normal string of losses.

Analysts and market pundits have tossed around the term "oversold" in the media for the last few weeks. Tonight we are going to examine the Stochastics oscillator, a technical tool used by traders and technicians. The oscillator was popularized by George Lane. Stochastics readings are plotted on a scale from 0 to 100. Stochastics refers to the strength or location of the current stock price in relation to its range over a set period of time. Readings above 80 suggest a market has approached an overbought level and may be due for a period of consolidation or retracement. When the numbers fall below 20 on the scale, the opposite scenario applies. Stochastic readings can be plotted for any time frame from minutes to years. Most charting programs offer this technical tool along with many other good studies to help determine the relative strength or weakness of a stock. Our purpose is not to find the fault in stochastics studies, rather show the effect of a strong trending market on the popular oscillator. Obviously stocks in the tech sector have been severely punished along with traders trying to pick a bottom in recent weeks. Analysts continue to suggest the market deeply oversold and long overdue for a bounce, and it probably is.

We ventured back a few months to find a "text-book" example of just how well stochastics readings can aid traders in finding a good entry or exit point. The third week of July the COMPX had moved up to near 4300. Stochastics readings had moved above 80 alerting traders either a period of consolidation or potential retracement could be near. July 19 the tech index began to loose momentum, with stocahstics readings crossing over, falling below the 80 on the scale, suggesting it may be the bears turn to control the board. By early August the Nasdaq had dropped to 3521, with stochastics readings on the other end of the scale. Our perception now would have been the tech index is a bit oversold and due for a bounce or at least a period of consolidation. Sure enough, a late day bounce on August 3 turned stochastics readings back north, just in time to catch a move back up to 4250.

In the first two days after traders returned from the Labor Day weekend, stochastics readings declined from overbought territory and ... you know the rest of the story. It took less than a week for the oscillator to reach the oversold level once again. The Nasdaq had moved back to between 3700 and 3800 with traders preparing to scour the market for their next potential buying opportunity. One month and 600 points later the COMPX is still oversold. So are stochastics readings failing to give the correct readings of the market? Not at all. The calculations are all correct. The oversold readings are definitely correct. The major averages are way "oversold" and certainly due for some kind of technical bounce. What may not be on target are trader's perceptions of just how negative the sentiment became over the last month. There are numerous reasons as to why and when the attitude of investors changed, those we won't dive into here.

An example of how a strong bullish sentiment can affect an oscillator occurred last year as the dreaded month of October came to a close. Stocks had begun to move higher in the middle of the month. By early November, the Nasdaq had eclipsed the 3000 level with stochastics readings reaching the red-zone, suggesting a consolidation or a pullback could be in store. Traders that couldn't bring themselves to click on their buy button due to the "overbought" conditions may have missed out on a move of nearly 1200 points - as the tech index moved up to 4200 by the beginning of the year. Notice that stochastic readings from the first part of November until early January traveled above 80 for most of the time, other than a brief dip the first part of December. Even then the index only dropped about 150 points before continuing on its path to new highs.

So are Stochastics readings doing their job? Absolutely. These relative strength indicators not only give solid readings for short-term rallies or dips in a market, but can also aid traders in determining just how strong the prevailing trend actually may be. As we said, stochastics and other oscillators are not meant to be stand-alone trading systems. They are simply another tool to include in our war-chest. This type of indicator is most useful in a choppy market or in spotting divergence as a strong trend comes to an end. Most traders believe they are much less valuable in the middle of a strong trending market. Combined with other studies, and the willingness to look beyond the actual numbers, the stochastics oscillator can give us a very good insight into not only possible market tops and bottoms, but to the strength of the prevailing trend as well.