The stochastics indicator was developed by George Lane, which measures the relationship between the closing price of an issue and its price range over a predetermined period of time.
In an interview with Lane, the Stochastic Oscillator “doesn't follow price, it doesn't follow volume or anything like that. It follows the speed or the momentum of price. As a rule, the momentum changes direction before price.”
Further, the mathematical number used in the time model for Stochastic is fourteen, and can represent days, weeks or months, depending on the technician’s objective. The chartist will initially look at the 14 months of the entire trading range of the industry in terms of a long-term view of a sector.
The Stochastic Oscillator’s bullish and bearish divergences can be used to predict reversals, suggesting it as the most important signal identified by Lane.
The developer also used this oscillator to determine bull and bear movement to calculate a future reversal, given that the indicator is range bound, and useful to identify overbought and oversold levels.
Three Versions of the Stochastic Oscillator
Stochastic oscillator has three versions and includes fast, slow and full. These versions are designed to smooth the oscillator and help eliminate some of the randomness.
The fast stochastic oscillator is the basic indicator and is usually the one represented, while the slow stochastic on the other hand smoothens the data provided by the raw data given in the fast stochastic. These two oscillators represent the same period and plot two lines.
· Fast %K and Slow %D
· %K typically uses 15, 10, or 5 days; %D typically uses 3
· Important: Intersection points
Stochastic is measured with the %K line and the %D line, marking the %D line that we closely watch as it will identify any major signals in the chart.
Mathematically, the %K line looks like this:
C = the most recent closing price
L5 = the low of the five previous trading sessions
H5 = the highest price traded during the same 5 day period.
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