Loading the player...

What is the 'Stochastic Oscillator'

The stochastic oscillator is a momentum indicator comparing the closing price of a security to the range of its prices over a certain period of time. The sensitivity of the oscillator to market movements is reducible by adjusting that time period or by taking a moving average of the result.
Stochastic Oscillator

BREAKING DOWN 'Stochastic Oscillator'

The stochastic oscillator is calculated using the following formula:

%K = 100(C - L14)/(H14 - L14)

Where:

C = the most recent closing price

L14 = the low of the 14 previous trading sessions

H14 = the highest price traded during the same 14-day period

%K= the current market rate for the currency pair

%D = 3-period moving average of %K

The general theory serving as the foundation for this indicator is that in a market trending upward, prices will close near the high, and in a market trending downward, prices close near the low. Transaction signals are created when the %K crosses through a three-period moving average, which is called the %D.

History

The stochastic oscillator was developed in the late 1950s by George Lane. As designed by Lane, the stochastic oscillator presents the location of the closing price of a stock in relation to the high and low range of the price of a stock over a period of time, typically a 14-day period. Lane, over the course of numerous interviews, has said that the stochastic oscillator does not follow price or volume or anything similar. He indicates that the oscillator follows the speed or momentum of price. Lane also reveals in interviews that, as a rule, the momentum or speed of the price of a stock changes before the price changes itself. In this way, the stochastic oscillator can be used to foreshadow reversals when the indicator reveals bullish or bearish divergences. This signal is the first, and arguably the most important, trading signal Lane identified.

Overbought vs Oversold

Lane also expressed the important role the stochastic oscillator can play in identifying overbought and oversold levels, because it is range bound. This range – from 0 to 100 – will remain constant, no matter how quickly or slowly a security advances or declines. Considering the most traditional settings for the oscillator, 20 is typically considered the oversold threshold and 80 is considered the overbought threshold. However, the levels are adjustable to fit security characteristics and analytical needs. Readings above 80 indicate a security is trading near the top of its high-low range; readings below 20 indicate the security is trading near the bottom of its high-low range.

RELATED TERMS
  1. Oscillator

    A technical analysis tool that is banded between two extreme ...
  2. Chande Momentum Oscillator

    A technical momentum indicator invented by the technical analyst ...
  3. Williams %R

    In technical analysis, this is a momentum indicator measuring ...
  4. OsMA

    An abbreviation for Oscillator - Moving Average. OsMA is used ...
  5. Overbought

    1. A situation in which the demand for a certain asset unjustifiably ...
  6. Divergence

    When the price of an asset and an indicator, index or other related ...
Related Articles
  1. Trading

    Triple Screen Trading System - Part 5

    Stochastics can be very effective as the second screen in this three-part system. Find out how to use this popular oscillator.
  2. Investing

    Stochastics: An Accurate Buy And Sell Indicator

    Find out how stochastics are used to create buy and sell signals for traders.
  3. Trading

    Combined Forces Power Forex Snap Strategy

    Stochastic and MACD oscillators can help isolate greater opportunities in range-bound markets.
  4. Trading

    How Do You Use the Stochastic Oscillator?

    A stochastic oscillator is a technical momentum indicator that compares a security's closing price to its price range over a given time period.
  5. Trading

    MACD And Stochastic: A Double-Cross Strategy

    The stochastic oscillator and the moving average convergence divergence (MACD) are two indicators that work well together.
  6. Investing

    Premier Stochastic Oscillator Explained

    This oscillator has been used since the 1950s by traders and investors to anticipate areas where the market may change direction.
  7. Trading

    Know the Forces At Play Behind the Buy/Sell Cycles

    Weekly Stochastics uncovers patterns of buying and selling pressure that can be predicted and capitalized upon by observant investors and traders.
  8. Trading

    Use The Percentage Price Oscillator: The "Elegant Indicator" For Picking Stocks

    Technical analysis is basically an attempt to disprove the credo that "Past performance is not indicative of future results." The percentage price oscillator, which measures momentum, is among ...
  9. Investing

    The Top Technical Indicators For Commodities Investing

    Traders can use "the usual suspects" (standard indicators for trend trading) when it comes to choosing indicators for investing in commodities. Here's how.
RELATED FAQS
  1. How do I read and interpret an Stochastic Oscillator?

    Understand the basics of the stochastic oscillator and how analysts and traders use this measure of trend momentum to predicts ... Read Answer >>
  2. What are the best technical indicators to complement the Stochastic Oscillator?

    Explore the function of the stochastic oscillator indicator, and discover other technical indicators traders use to complement ... Read Answer >>
  3. What is the difference between Stochastic Oscillator & Stochastic Momentum Index?

    Discover how the stochastic oscillator and the Stochastic Momentum Index differ and why the latter is considered a more refined ... Read Answer >>
  4. What precisely is a stochastic oscillator meant to predict?

    Gain a basic understanding of the stochastic oscillator and how this technical indicator is designed to predict reversals ... Read Answer >>
  5. How can a business eliminate deadweight loss from government regulation?

    Understand the basics of the stochastic oscillator and how to use this momentum metric in tandem with other indicators to ... Read Answer >>
  6. What are the differences between Relative Strength Index (RSI) & Stochastic Oscillator?

    Learn about some of the main differences between the relative strength index and the stochastic oscillator, two well-known ... Read Answer >>
Hot Definitions
  1. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  2. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  3. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  4. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  5. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  6. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
Trading Center