The Stochastic Oscillator

The stochastic oscillator is an indicator that uses support and resistance levels to determine the position of closing prices over time.

As with any invention or discovery, there are many different stories about how the stochastic indicator came into being. Some sources claim that it was developed by Dr George Lane while working at Investment Educators in 1950s; however others say Ralph Dyant made this famous stock trading tool known as "stochastics" before he became head of investment education department back then (or even someone else). The basic idea behind its development is comparing prices over certain period - analysts commonly use 14 periods because they're default setting on most platforms but traders can choose whatever number works best for them depending upon their objective.

The stochastic oscillator is a momentum indicator using support and resistance levels and refers to the position of the closing price in relationship to the price range over a period of time. It is calculated as the difference between the close and the low, divided by the price range (the difference between the high and low over a certain period of time). The result is noted %K, and for a 14-period %K, an analyst would use the most recent close and the absolute high and low over the 14-period preceding the analysis. Thus, the indicator takes a value between 0 and 1 and is expressed in percentage points. An additional line is plotted against %K acting as a trigger line and denoted %D. %D is just the 3-day simple moving average of %K.

The stochastic oscillator measures the position of the close relative to the high-low range over the chosen timeframe. A reading over 50% indicates that the close is somewhere in the upper half of the high-low range, whereas a reading under 50% indicates that the close is somewhere in the lower half of that range. A stochastic value over 80% indicates that the security is overbought and a crossover below that threshold represents a potential sell signal while a value below 20% indicates that the security is oversold and a crossover above that threshold indicates a potential buy signal. However, this indicator needs to be considered in conjunction with other indicators to provide meaningful insights. In fact, a reading over 80% could not be considered as a sell signal at all times, as securities can, at times, keep being overbought for a long period during a sustained uptrend.

Further Reading