Stochastic Oscillator - Momentum Indicator

Updated: 2024-02-24
2 min read
[Trading Indicators Stochastic Oscillator]

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.

Python Implementation

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