The Stochastic Oscillator shows closing price relative to the range of prices over a user-determined number of periods. Developed by George Lane, it is widely followed and is interpreted in a similar manner to RSI. Signals can be given from the crossing of thresholds, crossing of one or more of its own smoothing lines, and/or divergence with price.
The stochastic oscillator is generally displayed as two lines. The main line is called %K,. the second line is called %D. Only Mr. Lane knows why. I say K means "keep or kill" and D means "diluted".
The K factor is the number of days you are comparing . It is smoothed over a second factor. Then a second line is drawn which is just a moving average of %K line.
The concept is:
(Today's close minus the lowest low during the period tested (K factor))
divided by (the highest high during the period less the lowest low during the period)
this ratio is then multiplied by 100. Thus the values range from zero to 100.
When the ratio is less than 20 the stock is considered over sold in the time range.
When the ratio is greater than 80 the stock is considered over bought in the time range.
The traditional interpretation of Stochastics is when the %K and %D are above a threshold of 80 and %K then drops below %D, then they both drop below the 80 threshold, you have a good indication to sell or Kill. Similarly, to help determine market bottoms, %K and %D should be below 20, with %K rising above %D.
Also many people look at the crossover, when %K rises above the second line.
When a stock is flying, it can stay in the overbought category for weeks at a time.
The formula in TC2000 for the first line is :
STOC(K,D) where K is the period being tested such as 13 days or 8 days and M is the smoothing of that line such as 3 days.
The formula in Window on Wall Street ( & Metastock) for the first line is :
Stoch(K,D)
The % D formula for the second line is:
mov(stoch(KK,DD),EE,w) where w is weighted average(this can be replace by s-simple. e- exponential or other types of averaging depending on software) EE is number of days to use for the moving average. This is the second line
For example: Jerry Gatto (Big Dog) uses a (7,3,10) where 7 days are tested smoothed for 3 days and a second line is set up as the 10 day moving average of the first line.
Please see his post below for an explanation of how he uses it.
The traditional interpretation of Stochastics is when the %K and %D are above a threshold of 80 and %K then drops below %D, then they both drop below the 80 threshold, you have a good indication to sell. Similarly, to help determine market bottoms, %K and %D should be below 20, with %K rising above %D.
Also many people look at the crossover, when %K rises above the second line.
Other Variations: Jack Landis has created a weighted stochastics where five different stochastics lines are viewed separately and then blended together. When this weighted line bottoms and then rises, it is considered a change in trend up and then it tops and then falls, it is considered a change in trend down. The five lines he blends are: (8,3); (21,5); (34,8), (55,13) and (89,21). These numbers are all " fibonacci" numbers which were discovered by Leonardo Fibonacci in the 12th century. Each number is the sum of the two previous numbers in the series: 1,1,2,3,5,8,13,21,34,55,89,144,233,377, etc.
You can use the stochastics formulas to measure oscillation in indicators other than price. For example Dave Evans and others use the Stochastics of the Relative Strength Index(RSI) this is known as STOCHRSI- see his post on this one.
With stochastics, the key is that short term periods can give "false" buy or "sell" signals in some cases so you must use this indicator with others to confirm the expected price movement.
Andy Gabor |
