this article is all about the stochastic oscillator we're
gonna know what stochastic oscillator is
what it measures how to add it to the chart what you're looking for how to
interpret what you're reading I'm also going to explain what the difference is
between a fast stochastic and a slow stochastic.
well we're going to look at another oscillator today the
stochastic oscillator and it's similar in some ways to the relative strength
index the RSI that we've been looking at in our recent video so you might want
to check some of those out because there is some crossover in terms of concepts
between the two let's take a look now at what the stochastic oscillator is the stochastic oscillator works by looking at the same thing as the relative
strength index the RSI and the race of change oscillator and the thing that
they will look at is price momentum so they're all momentum oscillators
basically they're looking at the rate at which price is changing and the
stochastic oscillator
it's a pretty
venerable thing it has a long history of you some was actually developed in the
1950s by a technical analyst called dr. George Lane and the stochastic remains
a very popular technical indicator to this day and some further points then
about the stochastic oscillator like the relative strength index the RSI the
stochastic oscillator gives indications of when it thinks the market is
overbought and oversold it does this by looking at the current price and
comparing it to price in the past to look back period the difference here is
that the stochastic oscillator in that look bag is not just comparing price to
previous price levels but it's factoring in highest high and the lowest low
across the period of its look back in making its comparison and the value of
the oscillator is bounded between zero and a hundred and now moving on
how the stochastic oscillator actually works it appears like
other oscillators we've looked at below the main price chart so it appears as a
separate Charles and it plots two lines on that child first line it's what we
call percentage K and with trading to 1/2 zap that appears this kind of light the blue line and then it plots the second line which is percentage D as its name
and that appears as a default in trading to Matsu zap as a red line and so the
stochastic oscillator looks a bit like this so bounded between zero and a
hundred and then the default overbought region is any reading higher than 80
and the default oversold region is any value below 20 and then the two lines
sort of quite closely follow each other and occasionally crossover as we can
see in this illustration representing the stochastic let's move on now to look
at the calculation behind the stochastic oscillator so we have the percentage K
line that we talked about that is calculated according to this formula so
first of all we have Seen which is the current closing price and we subtract from that this low value L n that's the low across our look back stretch of time across n periods and then we divide through that number by H high over N periods - that low value and then we multiply the number by a hundred to give ourselves our percentage K so n as we said it was the number of periods for I look back comparison and the default value for n with trading - 1 - zap is 50 so you're looking back at the lows and the highs across 15 periods and then percentage D which is sometimes called the signal line is an average of percentage K values over D periods and the default for D is 3
that's a
pretty much a standard value that's always used for D 3 and it basically means
that our second online percentage D it's just a kind of smooth down version of
the percentage K line let's now look at adding the stochastic oscillator to a
chart using trading to one twos here we are in trading two ones whose webapp
and I'm looking at a daily chart of AstraZeneca so what I'm going to do is just
right click and select indicators oscillators and then we're going to look for
the stochastic oscillator now we've got a couple of choices here we have a slow
stochastic oscillator and up here we have a fast stochastic oscillator and
we'll explain what the difference between these two are a bit later on so for
the timing I'm just gonna round on the fast stochastic oscillator so what pops
this dialog box and we've got some various variables that we can choose we've
got that D period which as we just said the default is 3 the K period that was
n the number of periods for I look back foot percentage K 15 there as the
default as we said and then we can choose what I overbought and oversold
regions are 80 and 20 other standard we've got those colors I said light blue
for percentage K and red for percentage D so
I'm gonna click
confirm and then the oscillator appears there at the bottom of the screen we
can see our overboard and oversold regions marked on and then the light blue
percentage k line with the smoother averaged out percentage D line there and
you can see there's plenty of crossovers and plenty of times where they've
moved into overbought and oversold so let's now talk about how to use the stochastic
oscillator now there are a number of different ways in which the stochastic
oscillator can be used what I'm going to do here is just summarize three common
ways in which it is you so three different ways of using the stochastic first
one of which is to ease it just to indicate overbought and oversold regions and
use those as indications of potential reversals in price another way is to look
for crossovers of percentage K and percentage D and use those as trading
signals so
if you have percentage K crossing below percentage D then
you would sell if you have percentage K crossing above percentage D then you
buy and then finally divergences between price and oscillator so in the
previous video we looked at divergences with price and the RSI and basically
would be the same concept here so worth checking out that video to learn a bit
more about divergence and oscillators so focusing solely on overbought and
oversold indications is a very basic usage and that could be as simple as
seeing the oscillator move like here into the over board zone just making a
note that one of your inputs is telling you to keep an eye out for a possible
top in the market or another way to interpret that might be as crossing over
into over boards is your preliminary warning and then dipping out of over
boards could be a sell signal and vice versa here the oscillator dipping into
oversold could be a preliminary warning of a possible bottom and then climbing
back out of oversold could be a buy signal and explaining a bit more about
the second way of interpreting the stochastic oscillator
which was using crossovers as signals the percentage Kaline crossing below the
percentage d-line would be a sell signal so in the diagram above this here is a
sell signal that's an example of the percentage grade crossing below percentage
D and the percentage K line crossing above the percentage D line would be a buy
signal so once again in the diagram above a cross / like this here would be an
example of a buy signal and just a quick word on divergence to illustrate what
I mean by that let's say that this is our chance of price and we can see in
this snapshots of time that the market has been making successively higher
Peaks has been making higher highs if we look below at the stochastic
oscillator we can see that initially we had agreement between the oscillator
and price the oscillator was rising but here the oscillator has failed to make
a new high and it's starting to dip so we have divergence between price and the
oscillator and that could be a signal of a potential reversal and going back to
this summary of those three ways that I've been talking
about another idea might be to use all three together so that you could look
for overboard and oversold as you're kind of preliminary setup and then look for
a confirmation by looking for divergence between price and the oscillator and
then finally looking for a crossover of percentage K and percentage D as your
final signal to trade and finally let's talk about the difference between fast
and slow stochastic so the stochastic calculation that we've run through so far
is for what is known as the fast stochastic in trading - Wantage app now I've
mentioned before that one of the problems with oscillators can be the false
signals that they give basically the slow stochastic is an attempt to try and
reduce the number of false signals so the difference between fast and slow then
is about sensitivity the fast stochastic is more sensitive than the slow
stochastic oscillator the slow stochastics smooths out
the percentage Kaline by averaging over the periods and the
default for D is 3 in trading - ones whose app in other words the percentage
Kaline for the slow stochastic is actually like the percentage d-line and the
faster casting and then we average this value again over a number of periods
usually three again to get a percentage D for the slow stochastics so it's
percentage D for the slow stochastic is then an average of this smoother
percentage k here we are in the app again looking at that same chart of
AstraZeneca that we added the fast elastic to earlier so let's now add on the
slow stochastic and we'll make a comparison between the two so slow stochastic
oscillator and we can see that
we've got these two values for different periods that we're
averaging our line so we've got three as our default for averaging that slow k
and then we've got three for the averaging of that slow k to give us the d
percentage line so we'll click confirm and the slow stochastic is now at the
bottom below the fast elastic and we can see that it the percentage K line is
smoother here and the upshot of that is that if we're looking at say crossovers
of the lines as our signal that we get fewer of those crossovers than we do
with the more sensitive fast stochastic oscillator.