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Stochastic Indicator Purpose

Stochastic is an indicator developed by George C. Lane in the late 1950s to discover the speed or the momentum of price trend direction. The bullish and bearish divergences in the Stochastic Oscillator can be used to predict reversals. This indicator was the first important signal that Lane defined. If Stochastic Oscillator floats near 100 it means accumulation. And contrary, if stochastic lies near zero that indicates distribution.

The periods’ number used in this indicator can be different according to the reason for which the Stochastic Oscillator is used. Stochastic indicator consists of two lines:

  • % K compares the latest closing cost to the current trading range
  • % D is an indicator line calculated by smoothing % K

Stochastic Indicator Usage

Stochastic oscillator tool allows trader to identify the possible overbought and oversold areas, and should be measured within trend analysis. Commonly if the stochastic indicator climbs above 75, it is overbought are, and if the sign drops below 25, it considers oversold:

  • Stochastic indicator signals a SELL opportunity when crossing overbought boundary
  • Stochastic indicator signals a BUY opportunity when crossing oversold boundary

Convergence/divergence patterns may be a sign of possible trend weakness:

  • If the price climbs to a new high, but the indicator does not, that may be a sign of the uptrend weakness;
  • If the price falls to a new low, but the indicator does not, that may be a sign of the downtrend weakness.

Stochastic Indicator Calculation

Fast Stochastic Oscillator:

  • Fast %K = %K basic calculation
  • Fast %D = 3-period SMA of Fast %K

Slow Stochastic Oscillator:

  • Slow %K = Fast %K smoothed with 3-period SMA
  • Slow %D = 3-period SMA of Slow %K

Full Stochastic Oscillator:

  • Full %K = Fast %K smoothed with X-period SMA
  • Full %D = X-period SMA of Full %K

Stochastic = 100 x ((C – L)/(H – L))
Signal = average of the last three Stochastic values;

C – latest close price;
L – the lowest price over a given period;
H – the highest price over a given period.


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