Description
The Stochastic Oscillator (usually known just as Stochastic) is a momentum indicator, that was developed by George Lane in the 1950s. The Stochastic Oscillator is based upon the theory that prices move in waves, moving back and forth between an overbought level and an oversold level (even within strong trends). The Stochastic Oscillator is usually displayed as a stochastic line, and a signal line which is a moving average of the stochastic line. The Stochastic Oscillator is displayed on its own chart, separate from the price bars, and is the lower section in the example chart (full size chart).
Calculation
- Description : The Stochastic Oscillator (S) is a comparison of the most recent closing price (CP) and the recent range (R). The signal line is a simple moving average of the stochastic oscillator (SMAS).
- Calculation :
CP = (CLOSEn - LOW(L ... Ln))
R = (HIGH(H ... Hn) - LOW(L ... Ln))
S (%K) = 100 * (CP / R)
SMAS (%D) = (S + S1 + S2 + ... + Sn) / n
Trading Use
As the Stochastic Oscillator is both a momentum indicator, and an overbought / oversold indicator, it can be used with both trending and ranging markets, and can be used in both short and long term timeframes. There are several ways of interpreting the Stochastic Oscillator during trading. One of the most popular ways is to enter a long trade when the stochastic line crosses above the signal line, and enter a short trade when the stochastic line crosses below the signal line. A common variation of this technique is to only make entries when the crossover occurs below or above specific thresholds (usually 30 and 70).
