In the late 1950s, George Lane came up with the idea for the stochastic oscillator. It is an oscillator that compares the close of the current day to the high and low ranges over a certain number of days. This shows how a commodity is moving. Consistent closings near the high end of the range show that people are buying, while consistent closings near the low end of the range show that people are selling. It shows whether a good is being bought too much or sold too much. Here's how to figure out how to use the formula:
percent K = (Recent Close
-Lowest High (n) / Highest High (n) - Lowest Low (n)) x 100
percent D = the average of percent K over the last three periods.
And (n) is the number of times the math is done.
So, a 20-day stochastic oscillator would use the most recent close, the highest high of the last 20 days, and the lowest low of the last 20 days. The 14 time period is the main one used here. These formulas are given here only to help you understand. Most of the time, you won't have to figure out these numbers by hand because the software you use to make charts will do it for you.
How Do We Use a Stochastic Oscillator?
Stochastic Oscillators can be broken down into three main types. Slow, full, and fast. Most trading software uses the fast one by default. The oscillator in this case is made up of two lines. The first is percent K, which shows how fast the commodity is moving. Percent D is just a simple moving average of percent K, as we've already talked about, but it's still more important than percent K. Most of the time, the percent K line is the faster one and the percent D line is the slower one. A trader needs to watch out for when both the percent D line and the price move into the overbought or oversold areas. You can sell the commodity when it goes above 80 and then crosses over to start going down again. When it goes below 20 and starts going up again, you can buy it. Compared to the fast stochastic, the slow or full stochastic oscillators are smoother. But it's important to keep in mind that just because the oscillator is above 80 doesn't mean that the stock has been bought too much. It may well continue to trend upwards a long time after that.
Divergences
Sometimes strange things happen. There are times when the prices and the stochastic oscillator are not the same. When prices go up, the oscillator shows that it has been overbought, and the same is true when prices go down. This shows that the current trend is weakening. So, a bearish sign would be if the commodity went up but the percent D went down. But it's important to remember that the signal isn't a divergence until the percent K line crosses the percent D line in the opposite direction of the price. With the stochastic oscillator, you have to be careful because there are a lot of ways for it to jump around. Divergence trades work best when the oscillator drops below 80 once, goes back up, and then forms a double top and drops below 80 again.
This oscillator is not good to use on its own. It's best to get confirmation from as many different indicators as possible, but this indicator will give you a very good idea of a commodity's trend momentum.
