Due to the volatility in markets, traders always look for tools to reduce the uncertainty in estimating market outcomes. Technical indicators are used by traders, investors and analysts to anticipate this changing field. One of these technical indicators is the Stochastic Oscillator.
Stochastic Oscillator was developed by financial analyst George C. Lane in the late 1950s. It is a momentum technical indicator which means that it monitors the velocity of the highs and lows as well as the direction of the price.
Stochastic Oscillator is computed as follows:
%K = (Current Close – Lowest Low)/(Highest High – Lowest Low) * 100
%D = 3-day SMA of %K
Lowest Low = lowest low for the look-back period
Highest High = highest high for the look-back period
%K is multiplied by 100 to move the decimal point two places
Now, these formula can be easily accessed through trading software or programmed spreadsheets. After finding the value of the Stochastic Oscillator and preparing the chart, how do we interpret the valuable data at hand?
Stochastic Oscillator is measured from 0 to 100 on a percentage basis. When the indicator approaches and crosses over 80, the closing price of the stock will close near the top range. On the other hand, when the indicator is below 20, the closing price will be near the bottom range. Other indicators such as RSI can be used to supplement Stochastic Oscillator.
This technical indicator can be used to determine the divergence of the price from the Stochastic signal. If the stock moves higher than 80, there is bearish divergence and the stock is overbought. If the stock makes it below 20, there is bullish divergence and the stock is oversold.
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