The Stochastic Oscillator technical indicator compares where a securityβs price closed relative to its price range over a given time period.
The Stochastic Oscillator is displayed as two lines. The main line is called %K. The second line, called %D, is a Moving Average of %K. The %K line is usually displayed as a solid line and the %D line is usually displayed as a dotted line.
There are several ways to interpret a Stochastic Oscillator. Three popular methods include:
- Buy when the Oscillator (either %K or %D) falls below a specific level (for example, 20) and then rises above that level.Sell when the Oscillator rises above a specific level (for example, 80) and then falls below that level;
- Buy when the %K line rises above the %D line and sell when the %K line falls below the %D line;
- Look for divergences. For instance: where prices are making a series of new highs and the Stochastic Oscillator is failing to surpass its previous highs.
Stochastic Oscillator
Calculation:
The Stochastic Oscillator has four variables:
- %K period. This is the number of time periods used in the stochastic calculation;
- %K Slowing Period. This value controls the internal smoothing of %K. A value of 1 is considered a fast stochastic; a value of 3 is considered a slow stochastic;
- %D period. This is the number of time periods used when calculating a moving average of %K;
- %D smoothing method. The method (i.e., Exponential, Simple, Smoothed, or Weighted) that is used to calculate %D.
The formula for %K is:
%K = (CLOSE-LOW(%K))/(HIGH(%K)-LOW(%K))*100
where:
- CLOSE – is todayβs closing price;
- LOW(%K) – the lowest low in %K periods;
- HIGH(%K) – the highest high in %K periods.
The %D moving average is calculated according to the formula:
%D = SMA(%K, N)
where:
- N – smoothing period;
- SMA – Simple Moving Average.