A lot people look to religion or spirituality when things appear to be in chaos. But when the financial markets are looking out of control, investors should look up Vanguard Group founder John Bogle for reassurance.

BusinessWeek did just that, and Bogle was his same-old self: Investors should stay the course, ignore the volatility, but make sure that they have an adequate percentage of their portfolio in bonds. Of course, that right ratio depends on your time horizon and the size of your portfolio.

Bogle explains more intelligently than I can here why investors shouldn't do anything. As I said in my Volatile Market: Just ignore it, don't try to time it, individual investors (and the experts too) have a terrible record of timing the market. It's why the average investor's return is so much lower than the market's average return: We have a tendency to jump in and out at precisely the wrong times. What's the solution? Buy and hold!

I love Bogle's use of Shakespeare to describe the current market turmoil: "A tale told by an idiot -- full of sound and fury, signifying nothing."

Unlike many who have turned bearish after the market's recent decline, advisor Jim Stack fortuitously moved to a bear market stance in his model portfolio as the Dow was hitting its record high.

At the time he noted, "When the DJIA scores a new record high, yet there are twice as many stocks closing down for the day (as the number closing up), then something is wrong. Declining stocks overwhelmed advancing stocks by a 2:1 margin, an ominous divergence that has never occurred in the past 75 years of market history."

As such, in his InvesTech Market Analyst, he stated, "We are moving to a full bear market defensive mode." Since that timely market call, he has seen an additional warning sign that has added to his concerns.

In particular, he cites a rare "killer wave" signal from the Coppock Curve, a technical indicator developed 50 years ago by Edwin S. Coppock. It can be described as a 'barometer of the market's emotional state.' As such, it moves very slowly and methodically from one emotional extreme to another.

Mainly, the indicator has been used to signal low risk buying opportunities. Stack notes, "Over the past 8 decades, this indicator shows a remarkable track record when it comes to signaling the start of a new bull market for stocks."

George C. Lane developed the Stochastic Oscillator in the late 1950s, according to Stock Charts. You can view their page for the extensive, mathematical calculations behind the indicator because they can explain it much more simply than I can. However, here's the important thing: I've found that this indicator has predictive value in helping me spot overbought or oversold situations.

I never buy stocks simply because they are overbought -- the stock needs to be displaying the strength needed to stage a rebound or "bounce." For example, in the two situations I highlighted in a recent technically focused article, both of the stocks were oversold (one of them according to stochastics, the other from price action) and both were showing strength.

This is important because, in my experience, stocks can remain overbought or oversold for a very long time. While you might argue that, if this is the case, then why should someone even spend their time looking at the indicator? In my opinion, the same could be said about judging a stock's value -- a stock can remain over or undervalued for a long time before the true value is reached. That doesn't mean performing such measures is a waste of time.


As you can see from the chart, Stochastics certainly aren't a "holy grail" for market timing, if employed with the proper mindset, they do hold predictive value, in my opinion. While I'm sure efficient market theorists are going to attack me for that statement, I think the chart speaks for itself.

You can see that the first time the stock was "oversold" (bottom of oscillator), as soon as the stock began to rally, the rally continued for 10%+.

However, as you see, it is not flawless. For the stock's run from $23-$33, the indicator would have had you selling after just a small percentage of that move. But that's understandable in my opinion, because the market was playing catch-up in Microsoft as people realized that a low double digit earnings multiple was extraordinarily irrational for such an incredibly profitable company.

Through this post I've tried to explain how I use the Stochastic Oscillator so you can better understand what it means if you see it inside charts in my post. Feel free to comment with any questions!