a momentum oscillator that can warn of strength or weakness in the market, often well ahead of the final turning point.
- based on the assumption that when an instrument is rising it tends to close near the high and when an instrument is falling it tends to close near its lows.
The Stochastic Oscillator was developed by George C. Lane. It is a momentum indicator that shows the location of the current close relative to the high/low range over a set number of periods. Closing levels that are consistently near the top of the range indicate accumulation (buying pressure) and those near the bottom of the range indicate distribution (selling pressure).
%K is fast stochastic oscillator where as %D is slow stochastic oscillator.
%K compares the latest closing price to the recent trading range
%D is a signal line calculated by smoothing %K which is 3-period moving average of %K
In an upward-trending market, prices tend to close near their high, and during a downward-trending market, prices tend to close near their low. Transaction signals occur when the %K crosses through “%D”.
The reading below 20 is considered as oversold & above 80 is considered overbought.
According to Lane some of the best signals occurred when the oscillator moved from overbought territory back below 80 and from oversold territory back above 20.
It is as a buy/sell signal generator, buying when fast moves above slow and selling when fast moves below slow. Most traders use the Slow Stochastics because of its more reliable signals