1. Exploring Oscillators and Indicators: Introduction
  2. Exploring Oscillators and Indicators: Leading And Lagging Indicators
  3. Exploring Oscillators and Indicators: On-Balance Volume
  4. Exploring Oscillators and Indicators: Accumulation/Distribution Line
  5. Exploring Oscillators and Indicators: Average Directional Index
  6. Exploring Oscillators and Indicators: Aroon Indicator
  7. Exploring Oscillators and Indicators: MACD
  8. Exploring Oscillators and Indicators: RSI
  9. Exploring Oscillators and Indicators: Stochastic Oscillator
  10. Exploring Oscillators and Indicators: Market Indicators
  11. Exploring Oscillators and Indicators: Conclusion


By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.com

The stochastic oscillator is another well-known momentum indicator used in technical analysis. The idea behind this indicator is that the closing prices should predominantly close in the same direction as the prevailing trend.

In an upward trend the price should be closing near the highs of the trading range and in a downward trend the price should be closing near the lows of the trading range. When this occurs it signals continued momentum and strength in the direction of the prevailing trend.

The stochastic oscillator is plotted within a range of zero and 100 and signals overbought conditions above 80 and oversold conditions below 20. The stochastic oscillator contains two lines. The first line is the %K which is essentially the raw measure used to formulate the idea of momentum behind the oscillator. The second line is the %D which is simply a moving average of the %K. The %D line is considered to be the more important of the two lines as it seen to produce better signals.

The stochastic oscillator generally uses the past 14 trading periods in the calculation but can be adjusted to meet the needs of the user.

Calculation


There are three versions of the stochastic oscillator fast, slow and full. The purpose of each version of the stochastic is to smooth the oscillator and help remove some of the randomness. The fast stochastic oscillator is the basic version of the indicator and is the one represented by the above equations. The slow and full stochastics smooth the data that is provided by the raw data given in the fast stochastic. Both of these oscillators reflect the same period and plot two lines.

Slow Stochastic:


The number of periods used in calculating the slow %D can be adjusted to meet the user's needs.

Full Stochastic:


Stochastic Signal Generation
The main signal that is formed by this oscillator is when the %K line crosses the %D line. A bullish signal is formed when the %K breaks through the %D in an upward direction. A bearish signal is formed when the %K falls through the %D in a downward direction.


Divergence can also be used to formulate buy–and-sell signals. When looking for divergence the %D line is the one most used as it gives clearer signals due to its smoothed nature. A divergence signal is formed when the %D and the security move away from one another, signaling a weakening of the trend.


If the security is moving in an upward direction and the %D is moving in a downward direction this is a bearish sign. A bullish sign is formed when the %D is moving upward when the security is moving downward. If this divergence is happening when the %D is in an overbought (above 80) or an oversold (below 20) position on the oscillator the signal formed is much stronger. However, the signal is not considered complete until the %K line crosses the %D line in the opposite direction of the price trend.

The stochastic oscillator is a little more difficult to calculate compared to other technical indictors but none the less it is one of the more commonly used indicators. The indicator can be adjusted to any time frame but is normally set to equal 14 periods.


Exploring Oscillators and Indicators: Market Indicators
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

    MACD And Stochastic: A Double-Cross Strategy

    The stochastic oscillator and the moving average convergence divergence (MACD) are two indicators that work well together.
  3. 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.
  4. 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.
  5. Trading

    MACD And Stochastic: A Double-Cross Strategy

    Two indicators are usually better than one. Find out how this pairing can enhance your trading.
  6. Trading

    Stochastics: An Accurate Buy And Sell Indicator

    Stochastics measure the relationship between an issue’s closing price and its price range over a period of time.
  7. Trading

    4 Double-Cross Buy Signs

    Will the double crossover on MACD and Stochastic indicators trigger a move higher?
Frequently Asked Questions
  1. What's considered to be a good debt-to-income (DTI) ratio?

    Your debt-to-income ratio helps lenders determine your credit worthiness. Find out how to calculate your score and how to ...
  2. What is the difference between a loan and a line of credit?

    Learn to differentiate between lines of credit and standard loans, and determine when you are likely to use each method of ...
  3. What does a Chief Financial Officer (CFO) do?

    A CFO is responsible for accurate reporting of a company's financial information, investing the company's money and identifying ...
  4. How did George Soros break the Bank of England?

    George Soros pocketed $1 billion by betting against the British pound, cementing his reputation as the premier currency speculator ...
Trading Center