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In consideration of Steve's market plunging on the stochastic trigger, I
though I might put this brain teaser out and shake Steve's confidence in his
system a little ;-)
A weakness in system testing the stochastic (or practically any momentum
indicator) over historical data is that what constitutes OVERBOUGHT or
OVERSOLD are relative, i.e. it depends on the recent past as defined by the
number of bars in the look-back period and different existing market
conditions. Thus OVERBOUGHT or OVERSOLD values today may not have been last
year. Means though the signals generated now may be valid for trading,
testing a system historically will generate invalid results.
One way to overcome this is to substitute statistical measures of trend in
momentum formulas. Then, OVERBOUGHT or OVERSOLD values can confidently be
calculated at 2 standard deviations from the mean.
Sounds simple, but of course the devil is in the details.
Working hard to solve this one,
Rick
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