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. Signal Line

    Signal lines are used in technical indicators, especially oscillators, ...
  2. Klinger Oscillator

    The Klinger Oscillator was developed by Stephen Klinger to determine ...
  3. Commodity Channel Index - CCI

    The Commodity Channel Index​ (CCI) is a momentum based technical ...
  4. Norton High/Low Indicator

    The Norton High/Low Indicator leverages the Demand Index and ...
  5. Chaikin Oscillator

    An oscillator which measures the accumulation distribution line ...
  6. Stochastic Modeling

    Stochastic modeling is a form of financial modeling that includes ...
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. Trading

    Percentage Price Oscillator – An 'Elegant Indicator'

    The percentage price oscillator, which measures momentum, is among the more sophisticated tools in the technical analysis arsenal.
  3. Trading

    Do You Have The Right Settings On Your Stochastic?

    Use these helpful tips to unlock Stochastics' full potential.
  4. Investing

    The top technical indicators for commodity investing

    See how traders can use "the usual suspects" standard for trend trading when it comes to choosing indicators for commodities investing.
  5. Trading

    Three Stocks Headed Into Long-term Buy Cycles

    These beaten-down S&P 500 components are finishing up long-term sell cycles that should yield strong multi-month bounces.
  6. Trading

    How to Interpret the Volume Zone Oscillator

    Introduced in 2009, the volume zone oscillator (VZO) is gaining traction with traders and technicians.
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. Is a Slow Stochastic Effective in Day Trading?

    The good news is that most technical indicators can be adjusted to be of value to a day trader. Read Answer >>
  4. What is the difference between fast and slow stochastics in technical analysis?

    The main difference between fast stochastics and slow stochastics can be summed up in one word: sensitivity. Read Answer >>
  5. What are the top technical indicators used for range-bound trading strategies?

    Learn how to identify when a market is range-bound and what some of the technical indicators are that work best for trading ... Read Answer >>
  6. How do I effectively create a Range-Bound trading strategy?

    Understand the basics of trading range-bound securities, including how to profit from the relative predictability of the ... Read Answer >>
Hot Definitions
  1. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  2. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  3. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  4. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  5. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center