Stochastic Oscillator Stocks Analysis & Stochastic Oscillator Signals

Created by George C. Lane

The Stochastic Oscillator is a momentum indicator - it shows the relation between the current closing price relative to the high & low range over a given number of n periods. Oscillator uses a scale of 0-100 to draw its values.

This Oscillator is based on the theory that in an up trend market the price closes near the high of the price range & in a downwards trending market the price will close near the low of the price range.

The Stochastic Lines are drawn as 2 lines- %K & %D.

• Fast line %K is the main
• Slow line %D is the signal

3 Types of Stochastics Oscillators: Fast, Slow & Full Stochastics

There are 3 types are: fast, slow and full Stochastic. 3 indicators look at a given chart period for example the 14-day period, and measures how the price of today’s close compares to the high/low range of the time period that is being used to calculate the stochastic.

This oscillator works on the principle that:

• In an up-ward trend, price tends to close at the high of the candlestick.
• In a downward trend, price tends to close at the low of the candlestick.

This indicator shows the momentum of the trends, & identifies the times when a market is overbought or oversold.

Stocks Analysis & Generating Signals

The most common techniques used for analysis of Stochastic Oscillators to generate signals are cross-overs signals, divergence signals and over bought oversold areas. Following are the methods used for generating trade signals

Stock Crossover Trade Signals

Buy signal - % K line crosses above the %D line (both lines moving upwards)

Sell signal - %K line crosses below %D line (both lines moving downwards)

50-level Crossover:

Buy signal - when stochastic lines cross above 50 a buy signal is generated.

Sell signal - when stochastic lines cross below 50 a sell signal is generated.

Divergence Stock

Stochastic is also used to look for divergences between this indicator & the price.

This is used to determine potential trend reversal signals.

Upwards/rising trend reversal- identified by a classic bearish divergence

Trend reversal - identified by a classic bearish divergence

Downward/descending trend reversal- identified by a classic bullish divergence

Trend reversal - identified by a classic bullish divergence

Oversold/Overbought Levels on Indicator

Stochastic is mainly used to identify potential overbought and oversold conditions in price movements.

• Overbought values greater than 70 level - A sell signal forms when the oscillator rises above 70% & then falls below this level.

Overbought - Values Greater 70

• Oversold values less than 30 level - a buy signal is generated when oscillator goes below 30% & then rises above this level.

Oversold - Values Less Than 30

Trades are generated when Stochastic Oscillator crosses these levels. However, overbought/oversold levels are prone to whipsaws especially when the market is trending upward or downwards.