Now I lay me down to sleep ...Stochastics clarification
The following was borrowed from Omega Research, as I felt it might help bolster some of the due diligence efforts of others... plus, now one can avoid having to mull through the financial sites and TA books.
The Stochastic "Fast" indicator calculates the location of a current price in relation to its range over a period of bars. The settings used for the PAIR and DPTI post use the most recent 14 bars, the high and low of that period to establish a range, and the close as the current price. The calculation is then indexed and plotted as "FastK". A smoothed average of "FastK", known as "FastD", is also plotted. FastK and FastD plot as oscillators with values from 0 to 100. The direction of the Stochastics should confirm price movement. For example, rising Stochastics confirm rising prices.
Stochastics can also help identify turning points when there are non-confirmations or divergences. For example, a new high in price without a new high in Stochastics may indicate a false breakout. Stochastics are also used to identify overbought and oversold conditions when the Stochastics reach extreme highs or lows. Additionally, FastK crossing above the smoother FastD can be a buy signal and vice versa.
In English
Stochastics are made up of four individual calculations: FastK, FastD, SlowK, SlowD. The core of the calculations are based upon the FastK value which is calculated in the following manner:
FastK(Length = (C - L)/(H - L)*100
where
L = Lowest Low of a specified period
H = Highest High of a specified period
C = Today?s Close
Length = Specified period of time
FastD is an exponentially smoothed FastK using a .5 factor in the smoothing. Both the FastK and FastD are used in the Stochastic-Fast indicator. The slow Stochastic is created with the SlowK which equals the FastD. The SlowD is a three period smoothed SlowK.
When using Stochastics, most people use the slow Stochastic since its smoothed values are less subject to whipsaws. The indicator itself is composed of a percentK and a percentD line that will always oscillate between 0 and 100; a higher value indicates an overbought market while a lower value indicates an oversold market.
A value greater than 80 is usually used as an overbought signal and a value less than 20 is used for the oversold signal. The 80 value is often called the sell zone and the 20 value is called the buy zone. The crossover of the buy zone and sell zone values in conjunction with a percentD and percentK crossover is a good indication of a switch in trend direction.
George C. Lane, developer of the Stochastic, says the only valid signal derived from the percentD is a divergence from the price where the divergence is an indication of a trend reversal. When using the percentK and the percentD together, crossovers of the two generate valid signals and should be used to indicate rising and declining markets. |
