What Is the Worden Stochastic?
The Worden Stochastic indicator quantifies the percentile rank of the most recent closing price compared to all other closing prices over a specified lookback period. Traders leverage this indicator to identify whether a particular security is overbought or oversold, to provide trade signals, and to detect divergences that may hint at price reversals.
Key Takeaways
- The Worden Stochastic differs from other stochastics by ranking closing prices, assigning values based on the recent close’s position relative to prior closes.
- Like other stochastic indicators, the Worden version offers overbought and oversold levels, alongside potential trade signals using signal line crossovers.
- A reading above 80 indicates overbought conditions, while a reading below 20 signifies oversold conditions. However, these readings are not standalone reasons for buying or selling.
Understanding the Worden Stochastics
Peter Worden developed the Worden Stochastic to quickly recognize new trading ranges, providing a possibly more accurate trading range indication than traditional stochastics. Unlike traditional versions that consider high, low, and closing prices, the Worden Stochastic relies on ranking to avoid bias towards outlier periods.
The Worden Stochastic formula is:
(100/n - 1) x Rank
“n” represents the number of closing values in the range, while “Rank” signifies the closing price’s position in an ascending list. All stochastic indicators, including the Worden Stochastic, measure the closing price level relative to its range over a specific time frame. Traders utilize these readings to gauge if a security is trading at potentially overbought or oversold levels.
Trading With the Worden Stochastics
Typically, a stochastic reading above 80 is considered overbought, while a reading below 20 suggests oversold conditions. Nonetheless, traders should confirm these outcomes with other technical indicators or chart patterns. Overbought does not necessarily imply a sell signal, nor does oversold unconditionally indicate a buy signal. In strong uptrends, stochastic readings often exceed 80, whereas strong downtrends usually show readings below 20.
The stochastic includes a signal line. When the stochastic moves above this line, some traders view it as a buy signal. Conversely, crossing below the signal line can indicate a sell signal. Combining these observations, traders might consider assets in a rising trend and look for the Worden Stochastic to fall below 30 or 20. When the stochastic ascends above the signal line, or exits oversold territory, it could be a cue to purchase the asset. Again, this example is for illustration and not a strategy recommendation.
Additionally, traders observe bullish or bearish divergences between price trends and stochastic readings. Higher price peaks alongside lower stochastic peaks indicate potential price reversals. If the stochastic forms higher lows while the price hits lower lows, it’s a bullish signal hinting at a possible upward price reversal. However, divergences are not reliable timing signals and should be used in conjunction with other analyses and trade signals.
Worden Stochastics vs. Stochastic Oscillator
The Worden Stochastic sets itself apart by its calculation method. Traditional fast or slow stochastic oscillators compare recent closing prices to high and low values over a time frame. The Worden variant ranks closing prices and uses these rankings in computations.
Limitations of the Worden Stochastics
The indicator may produce numerous false signals. During pronounced trends, it can remain in overbought or oversold zones for prolonged periods. Additionally, multiple signal line crossovers might not lead to significant price movements, and divergence with price is not a reliable timing mechanism.
Real-World Example of the Worden Stochastics
In this example, we employ the default settings (signal line in blue) over a four-month period, outlining three complete cycles for Disney stock.
In April, the indicator reverses higher at the oversold level, while the price oscillates sideways. In early May, a double bottom on the indicator heralds a rally lasting nearly three weeks. By mid-May, a crossover triggers a new sell cycle as the price retests new support around 100. Early June sees the indicator turning higher as prices approach new highs. As the price pulls back, a bearish crossover pushes the stochastics into oversold territory late in June. Given the overall uptrend, a subsequent bullish crossover above the signal line near early July could render a long trade favorable.
By July and early August, the indicator remains in overbought territory and any bearish crossovers could serve as sell signals. A stochastic drop below 80 might also act as a sell signal.
Related Terms: Stochastic Oscillator, Relative Strength Index, Bollinger Bands, Moving Average Convergence Divergence (MACD).
