Hope this helps:
Stochastics:
This is part of a larger Technical Analysis site provided by Equity Analytics, Ltd.
The stochastic oscillator compares where a security's price has closed relative to its price range over
a specifically identified period of time. George Lane, who developed this indicator, theorized that in
an upwardly trending market, prices tend to close near their high; and during a downward trending
market, prices tend to close near their low. Further, as an upward trend matures, price tends to
close further away from its high; and as a downward trend matures, price tends to close away from
its low.
The stochastic indicator attempts to determine when prices start to cluster around their low of the
day for an uptrending market, and when the tend to cluster around their high in a downtrending
market. Lane's theory is these are the conditions which indicate a trend reversal is beginning to
occur.
The stochastic indicator is plotted as two lines. They are the %D line and the K line. The D line is
more important than the K line. The stochastic is plotted on a chart with values ranging from 0 to
100. The value can never fall below 0 or above 100. Readings above 80 are strong and indicate that
price is closing near its high. Readings below 20 are strong and indicate that price is closing near its
low.
Ordinarily, the %K line will change direction before the D line. However, when the D line changes
direction prior to the K line, a slow and steady reversal is usually indicated.
When both %K and D lines change direction, and the faster K line subsequently changes direction to
retest a crossing of the D line, but doesn't cross it, this is a good confirmation of the stability of the
prior reversal.
A very powerful move is underway when the indicator reaches its extremes around 0 and 100.
Following a pullback in price, if the indicator retests these extremes, a good entry point is indicated.
Many times, when the %K or D lines begin to flatten out, this is an indication that the trend will
reverse during the next trading range.
Quite often, divergence's set up on the chart. That is, price may be making higher highs, but the
stochastic oscillator is making lower lows. Or conversely, price may be making lower highs, and the
stochastic oscillator is making higher highs. In either case, the indicator usually is demonstrating a
change in price before price itself is changing.
The formula for %k is as follows:
%K = 100[(C - L5close)/(H5 - L5)]
Where:
C = the most recent close
L5 = the lowest low for the last 5 trading periods
H5 = highest high for the same five trading periods
%D is a smoothed version of the K line. Usually, 3 periods is used. The K formulas is as follows:
%D = 100 X (H3/L3)
Where:
H3 = the 3 period sum of (C - L5)
L3 = the 3 period sum of (H5 - L5) |
