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A stochastic oscillator is a technical investment analysis tool used to measure a security’s closing price in comparison to its price range over a given period of time.  The process is used to help traders determine the best time to buy or sell a security.  This is due to the theory that as a security’s price increases, it will tend to close at its highest point of a given period of time.  Conversely, as the price declines, its close price will fall to its lowest point.

The stochastic oscillator is calculated by determining two numbers.

The first is a formula:                            

%K = 100[C – L of n)/(H of n – L of n)]                                                   

C = the most recent closing price    

L of n = the lowest price of the n previous trading sessions·        

H of n = the highest price of the n previous trading sessions   

The default number for n previous trading periods is 14, which could be 14 weeks, days or hours.

The second factor is %D, which is a three-period moving average of %K

The numbers are plotted on a graph side-by-side.  Analysts look for fluctuations between zero and 100.  If the stochastics are above 80, the security is thought to be overbought. If they are below 20, the security is considered to be oversold.  A buy or sell signal is when both the %K and %D are above or below the overbought or oversold points. 

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