| -> | | | | 3-day simple moving average. The normal stochastic |
| The stochastic oscillator was presented by George | | | | is sometimes referred as "fast" to distinguish it from |
| Lane in 1950s. George Lane designed a number of | | | | smoothed "slow" stochastic. Some technicians believe |
| indicators that withstood the test of time. These | | | | that slow stochastic provides more accurate signals. |
| indicators rank among most popular and widely used. | | | | This technique is simple and elegant. Technical analysis |
| Lane's stochastic oscillator can warn of strength or | | | | software does all the calculations, and makes analysis |
| weakness in the market ahead. As a momentum | | | | easier and available not only for professional traders, |
| indicator stochastic helps to find turning points within | | | | but even for average investors. |
| the scope of the more significant trend. To achieve | | | | 2. The second important signal generated by Lane's |
| better result, stochastic needs to be used in | | | | Stochastic is the crossover between the %D and |
| conjunction with trend analysis or trend following | | | | %K lines. It is considered a buy signal when the %K |
| indicators. | | | | line rises above the %D line and a sell signal when the |
| The best technique is to use stochastic with trend | | | | %K line falls below %D. To avoid whipsaws you can |
| analysis to time trades in the duration of the major | | | | wait for crossover accruing within overbought |
| trend. Stochastic indicates short-term price fluctuation | | | | oversold area, or after a peak or bottom in the %D |
| within the major trend support and resistance level. | | | | line. |
| Using these two techniques in conjunction gives a | | | | 3. The third and one of the most reliable signals is |
| number of excellent opportunities. | | | | divergence between %D and the price. A bullish |
| The basic assumption behind the indicator is that in an | | | | divergence occurs when price makes a series of |
| upward trend price tend to close near the highs of | | | | lower lows while %D makes a series of higher lows. |
| the day. In downward trend price tend to close near | | | | A bearish divergence occurs when price makes a |
| their low. The stochastic oscillator is plotted as two | | | | series of higher highs while %D makes a series of |
| lines, a fast line called %K, and a slow line %D. | | | | lower highs. |
| %K = 100 * (C - LN) / (HN - LN) | | | | Now when we know the basics, we can discuss the |
| %K - fast stochastic | | | | advanced techniques. The most important and |
| C - latest close price | | | | difficult question is when to apply Lane's Stochastic. |
| HN - highest high for N periods | | | | The basic assumption of stochastic is the certain |
| LN - lowest low for N periods | | | | market cyclicity. The simple technique will present |
| %D - is an 'n' periods simple moving average of %K | | | | useful signals for intermediate top and bottom in |
| Usually n = 3 periods. | | | | trading market, but in strong trending market |
| George Lane recommended a 14 period | | | | stochastic is too sensitive to generate reliable signals. |
| measurement. The number can be varied to change | | | | We would like to stress it again that stochastic |
| the sensitivity and desired time frame. Period can | | | | oscillator is a momentum indicator. Momentum |
| represent days, weeks or month. | | | | indicators help identify turning points, but it needs to |
| Lane's stochastic is a percentage indicator. It always | | | | be used in conjunction with trend following indicators |
| stays between 0 and 100. | | | | or trend analysis. |
| Market technicians use stochastic oscillators as a | | | | The simplest and one of the most popular trends |
| timing indicator for signals of market reversal. There | | | | following indicator is the moving average. A lot of |
| are three main signals the stochastic generates. | | | | technicians use stochastic oscillator in conjunction with |
| 1. The level above 80% is considered as an | | | | MACD - moving average converge/divergence |
| overbought warning signal, and the level below 20% | | | | indicator. MACD is the trend following indicator that |
| is used as oversold warning signal. This signal should | | | | can help to identify the direction of the major trend. |
| be considered only in conjunction with other factors. | | | | Then you can use the stochastic signals to trade in |
| Lane recommended waiting when stochastic rises | | | | the direction of the major trend. |
| above 80% and sell when it falls below this level. | | | | Using oscillators in conjunction with trend analysis and |
| Similar for level below 20% it is recommended | | | | patterns recognition is probably one of the most |
| waiting for rise back above 20%. | | | | profitable techniques devised for the experienced |
| The stochastic oscillator is very sensitive to the price | | | | trader. Oversold/overbought conditions and stochastic |
| movement and usually gives too many signals and to | | | | divergence usually confirm termination patterns and |
| many whipsaws. One way to limit the sensitivity is | | | | give useful tips about when the current trend is |
| using 5% and 95% level as more reliable. Some | | | | about to change. |
| technicians prefer smoothing normal stochastic by | | | | |