Knowing what an indicator measures is the first step to really understanding it. Sure, the formulas can get technical, but it is important to understand an indicator before using its for trading. Today we are going to dive into the Stochastic Oscillator, a popular momentum oscillator developed by George Lane.
The Stochastic Oscillator is composed of two parts: %K and %D. %K measures the current price level versus the high-low range over a given look-back period, typically 14 days. %D is a 3-day SMA of %K and acts as a signal line. This discussion will focus on %K, which is referred to as the Stochastic Oscillator in this article.
The Stochastic Oscillator fluctuates between zero and one hundred. High values (80-100) indicate that prices are at the upper end of the high-low range for the look-back period. Low values (0-20) indicate that prices are at the bottom end of the high-low range. Middle values (40-60) indicate that prices are near the midpoint of the high-low range.
The example above shows QQQQ with the Fast Stochastic Oscillator (%K). QQQQ is trading near the top of its 14-day range in October (yellow area). As expected, the Fast Stochastic Oscillator is above 80 currently and has been largely above 80 since early last week. This tells us that QQQQ moved to the top of its 14-day range early last week and remained at the top of its 14-day range for over a week. In other words, it remained strong. Don’t forget that the 14-day range changes as new days are added and older days fall off.
by Arthur Hill
