StochasticOscillator

  • Stochastics measures the momentum of price. If you visualize a rocket going up in the air � before it can turn down, it must slow down. Momentum (rate) always changes direction before price.
  • Stochastics attempts to predict turning points by comparing the closing price of a security to its price range. Prices tend to close near the extremes of the recent range just before turning points. You can see price extremes and close prices by looking at "Candle" price charts or "OHLC" (open high low close) price charts.
  • The Stochastic oscillator helps avoid buying at high prices or shorting at low prices, and suggests buy/sell signals when the stock is at lows/highs.
  • K is the fraction of extreme range over a historical period of time (default 14 days), called K(14), normalized to %-age on a 0-100 scale. D(amped) is a 3-period moving average of K, or D(3). Together, the two lines on a chart are often refered to as K(14,3).
  • The Stochastic Oscillator is above 50 when the close is in the upper half of the range and below 50 when the close is in the lower half. K can hang above 80 or stay below 20 for a month or more.
  • Stochastic indicator becomes significant below 20% or above 80% (0-100 scale). A divergence between K & D alerts one to the extreme position (cusp of D) and the actual signal event is when "K cross over D". Mostly ignore crossings when the signals hover between 20-80%.
  • There are two types of Stochastic: fast Stochastic and slow Stochastic. Both consist of K & D. With the slow oscillator, K is the fast oscillator damped signal (D). Sometimes the phrase "Full Stochastic" is used when you can customize the periods, so K(14,3) might become K(26,5).
  • Low levels mark oversold markets (closes near the bottom of range), and high levels mark overbought markets (closes near the top of range). Overbought means too high, ready to turn down. Oversold means too low, ready to turn up.
  • This indicator works well if you use it with another trend-following indicator and take only those Stochastic signals that point in the direction of the main trend.
  • Do not buy when the Stochastics is above its upper reference line and do not sell when it is below its lower reference line. This is probably the most useful way to use the Stochastic. Other technicals give action signals most of the time. The Stochastic identifies "no trade" zones.
    • Moving averages are better than the Stochastics at identifying trends
    • MACD-Histogram is better at identifying reversals
    • Channels are better at identifying profit targets
    • ADX is quicker at catching entry and exit points.
  • While momentum oscillators are best suited for trading ranges, they can also be used with securities that trend, provided the trend takes on a zigzag format. Pullbacks are part of uptrends that zigzag higher. Bounces are part of downtrends that zigzag lower. In this regard, the Stochastic Oscillator can be used to identify opportunities in harmony with the bigger trend.
Yahoo Example
  • IAU gold stock (just change the stock ticker symbol in the URL to check your favorite stock)
References

Created by brian. Last Modification: Monday 26 of September, 2011 15:55:24 CDT by brian.