We have previously mentioned that all the technical indicators that can be found on our website work on all time frames but there are a few things you have to keep in mind when using them in day trading.
Gaps Can Give "False" Data To Your Technical Indicator
When a stock or a futures gaps either down or up the technical indicator will not be able to properly incorporate the gap into the formula. This can, for example, mean that when using an overbought/oversold technical indicator after a gap it will not show a true overbought/oversold reading.
Let us say that price gaps down 3%. This price move would normally be big enough for the Stochastic to become oversold but because the Stochastic considers the gap as part of the current bar then it only puts a small weight on the gap. The higher the settings on Stochastic the less weight it puts on the gap.
Stochastic is looking back over X amount of bars meaning it is using prior days price action in the formula. So Stochastic then "think" that it is only 1 selloff bar and not a major price change which a 3% gap is. So it is important to understand how the Stochastic is calculated and what it tells the trader.
Another thing the trader needs to know is that a decent size gap occurs because of one or another event. Let us for example say that company announced earnings and the stock gaps down 2%. Market opens and you see that stochastic is oversold. Would you buy using the Stochastic? Hopefully not. We do not really care that it was bad earnings but what we do care about is that there was a gap that arose because of a major event. An event that makes prior days last bars irrelevant and if they are irrelevant then Stochastic calculated based on those bars should also be irrelevant. And If Stochastic is irrelevant then your trade is wrong...you get the drift?
So be careful using technical indicators after a gap down or gap up. Wait for either a trend or established support/resistance areas before using your technical indicators for entry.