A:

Developed by George C. Lane in the 1950s, the stochastic oscillator is one of a handful of momentum metrics used by analysts and traders to predict potential reversals. Instead of measuring price or volume, the stochastic oscillator compares the most recent closing price to the range for a given period. The standard period is 14 days, though this can be adjusted to meet specific analytical needs. The stochastic oscillator is calculated by subtracting the low for the period from the current closing price, dividing by the total range for the period and multiplying by 100. For example, if the 14-day high is 150, the low is 125 and the current close is 145, then the reading for the current session would be (145-125)/(150-125)*100, or 80. By comparing current price to the range over time, the stochastic oscillator reflects the consistency with which price closes near its recent high or low.

The stochastic oscillator is range-bound, meaning it is always between 0 and 100. This makes it a useful indicator of overbought and oversold conditions. Traditionally, readings over 80 are considered in the overbought range, and readings under 20 are considered oversold. However, these are not always indicative of impending reversal; very strong trends can maintain overbought or oversold conditions for an extended period. Instead, traders should look to changes in the stochastic oscillator for clues about future trend shifts.

Stochastic oscillator charting generally consists of two lines: one reflecting the actual value of the oscillator for each session, and one reflecting its three-day simple moving average. Because price is thought to follow momentum, intersection of these two lines is considered to be a signal that a reversal may be in the works, as it indicates a large shift in momentum from day to day.

Divergence between the stochastic oscillator and trending price action is also seen as an important reversal signal. For example, when a bearish trend reaches a new lower low, but the oscillator prints a higher low, it may be an indicator that bears are exhausting their momentum and a bullish reversal is brewing.

RELATED FAQS
  1. How do I use Stochastic Oscillator to create a forex trading strategy?

    Learn about the stochastic oscillator and how to it is used to create an effective forex trade strategy, including how to ... 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 are the most common momentum oscillators used in day trading?

    Take a look at some commonly used momentum oscillators that can also be used for intraday trading, such as stochastic oscillators ... Read Answer >>
  5. Why is the Ultimate Oscillator important for traders and analysts?

    Understand the thinking behind the design of the ultimate oscillator and learn the primary trading signals that it generates ... Read Answer >>
  6. What is the difference between fast and slow stochastics in technical analysis?

    The main difference between fast and slow stochastics is summed up in one word: sensitivity. The fast stochastic is more ... Read Answer >>
Related Articles
  1. Investing

    Stochastics: An Accurate Buy And Sell Indicator

    Find out how stochastics are used to create buy and sell signals for traders.
  2. 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.
  3. 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.
  4. Trading

    Do You Have The Right Settings On Your Stochastic?

    Use these helpful tips to unlock Stochastics' full potential.
  5. 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.
  6. 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 ...
  7. 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.
  8. Trading

    An Introduction To Oscillators

    Find out how this indicator may help improve the average investor's entry and exit points.
RELATED TERMS
  1. Stochastic Oscillator

    A technical momentum indicator that compares a security's closing ...
  2. Oscillator

    A technical analysis tool that is banded between two extreme ...
  3. Williams %R

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

    The Worden Stochastics indicator represents the percentile rank ...
  5. Commodity Channel Index - CCI

    The¬†Commodity Channel Index‚Äč (CCI) is a momentum based technical ...
  6. Stochastic Volatility - SV

    A statistical method in mathematical finance in which volatility ...
Hot Definitions
  1. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  2. Whole Life Insurance Policy

    A life insurance contract with level premiums that has both an insurance and an investment component. The insurance component ...
  3. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  4. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. ...
  5. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability of potential investments.
  6. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
Trading Center