Stochastic Oscillator
Posted On at by Forex KnowledgeTraders sometimes refer to the Stochastic (pronounced sto kas tik) Oscillator, as "Stochastics," because it employs two lines to give a single signal. An overbought/oversold indicator developed by Dr.. George Lane, the Stochastic Oscillator compares where a stock's price closed at to its price range over a specific period of time. The driving principle: as a price rises in an uptrend, the closing price moves to the upper end of the recent price range. In a downtrend, closing prices usually sink to the b,ottom of the range. We won't study the actual calculation here. And believe me, if you ever see it, you'll be glad we didn't! Again, the Stochastic Oscillator is displayed in two lines. The major line is called the "%K." The second line is referred to as the "%D," and is a 3-day moving average of the %K. Many times you'll see the % K as a solid line and the % D as a dotted line. Stochastics come in two flavors-fast Stochastics,and slow Stochastics. The one described in the previous paragraph is fast Stochastics. In slow Stochastics, the slow %K equals the fast %D, with the slow %D equaling
a 3-day average of the fast %D.
Got that? If not, cheer up. Your charting software understands the equations needed to calculate the display. For the record, I prefer the fast Stochastics, although slow Stochastics has a smoother look. In tandem, the %K and %D lines rise and fall between zero and 100. Readings above 80 are considered overbought, and readings below 20 are oversold. The Stochastics buy/sell signal is as follows:
Buy-when the lines are below 20, and the faster %K line crosses above the slower %D line. (Watch out for short-term crossovers. Use indicators to confrrm the reversal.)
Sell-when the lines are above 80, and the %K crosses the %D to the downside.
Look for divergences, just as you do with the RSI. An example: Bossy Bank makes a new high. At the same time, the Stochastics moves sideways or hooks to the downside. That's called a "bearish divergence." Assume the price will soon follow the Stochastics south. Or, while Bossy Bank experiences a normal consolidation period in an uptrend, the Stochastic suddenly hooks up. Referred to as a "bullish divergence," it tells you to prepare for a continuation of Bossy Bank's uptrend within the next few time periods.
a 3-day average of the fast %D.
Got that? If not, cheer up. Your charting software understands the equations needed to calculate the display. For the record, I prefer the fast Stochastics, although slow Stochastics has a smoother look. In tandem, the %K and %D lines rise and fall between zero and 100. Readings above 80 are considered overbought, and readings below 20 are oversold. The Stochastics buy/sell signal is as follows:
Buy-when the lines are below 20, and the faster %K line crosses above the slower %D line. (Watch out for short-term crossovers. Use indicators to confrrm the reversal.)
Sell-when the lines are above 80, and the %K crosses the %D to the downside.
Look for divergences, just as you do with the RSI. An example: Bossy Bank makes a new high. At the same time, the Stochastics moves sideways or hooks to the downside. That's called a "bearish divergence." Assume the price will soon follow the Stochastics south. Or, while Bossy Bank experiences a normal consolidation period in an uptrend, the Stochastic suddenly hooks up. Referred to as a "bullish divergence," it tells you to prepare for a continuation of Bossy Bank's uptrend within the next few time periods.
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