Stochastic Oscillator - Momentum Indicator
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About
The Stochastic Oscillator is a momentum indicator that shows the location of the close relative to the high-low range over a set number of periods. It was developed by George Lane in the 1950s.
Calculating
Formula
The Stochastic Oscillator is calculated using the following formula:
%K = 100[(C - L14) / (H14 - L14)]
where:
- C = the most recent closing price
- L14 = the lowest price traded of the 14 previous trading sessions
- H14 = the highest price traded during the same 14-day period
- %K = the current value of the stochastic indicator
The “%D” line is then a 3-day simple moving average of %K.
Pros and Cons
Pros:
- The Stochastic Oscillator can provide insights into potential overbought and oversold conditions.
- It can also be used to identify divergences, short-term overbought and oversold conditions, and generate trading signals.
Cons:
- The Stochastic Oscillator can stay in overbought or oversold territory for a long time, leading to many false signals in trending markets.
- As a lagging indicator, it might send a late signal, causing the trader to miss a big part of the trend.
Example of signals
- Buy Signal: A buy signal might be identified when the Stochastic Oscillator crosses above the %D line (bullish divergence).
- Sell Signal: Conversely, a sell signal might be identified when the Stochastic Oscillator crosses below the %D line (bearish divergence).
Use in Real Trading
The Stochastic Oscillator is typically used with other oscillators such as the Relative Strength Index (RSI) and the Commodity Channel Index (CCI) to confirm trading signals.