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Stochastic
Description:
Stochastic (sto kas' tik) adj . . 2. Math . designing a process having an infinite progression of jointly distribution random variables. - Webster's New World Dictionary
The Stochastic Oscillator compares where a security's price closed relative to its price range over a given time period.
Interpretation
The Stochastic Oscillator is displayed as two lines. The mail line is called %K. the second line, called %D, is a moving average of %K. the %K line is usually displayed as a solid line, and the %D, and the %D line is usually displayed as a dott3ee line.
There are several ways to interpret a Stochastic Oscillator. Three popular methods include:
- Buy when the Oscillator (either %K or %D) falls below a specific level (e.g., 20) and then rises above a specific level (e.g., 80) and then falls below that level.
- Buy when the %K line rises above the %D line and sell when the %K line falls below the %D line.
- Look for divergences, for example, where prices are making a series of new highs and Stochastic Oscillator is failing to surpass its previous highs.
Calculation
The stochastic oscillator has four variables:
- %K Periods. This is the number of time periods used in the stochastic calculation.
- %K slowing periods. This value controls the internal smoothing of %K. A value of 1 is considered a fast stochastic; a value of 3 is considered a slow stochastic.
- %D Periods. This is the number of time periods used when calculating a moving average of %K. the moving average is called %D and is usually displayed as a dotted line on top of %K.
- %D Method. The method (i.e., Exponential, Simple, Time Series, Triangular, Variable, or Weighted) that is used to calculate %D.
The formula for %K is:
Today's Close - Lowest Low in %K Periods)
( ------------------------------------------------------------------------- ) * 100
Highest High in %K Periods - Lowest Low IN %K Periods
For Example, to calculate a 10-day %K, first find the security's highest-high and lowest-low over the last 10 days. As an example, let's assume that during the last 10 days the highest-high was 46 and the lowest-low was 38-a range of 8 points. If today's closing price was 41, %K would be calculated as:
46 - 38 37.5 = ( -------------------------- ) * 100
41 - 38
The 37.5 percent in this example shows that today's close was at the level 37.5 percent relative to the security's trading range over the last 10 days. If today's close was 42, the Stochastic Oscillator would be 50 percent. This would mean that the security closed today at 520percent, or the midpoint, of its 10-day trading-range.
The above example used a %K Slowing Period of 1 day (no slowing). If you use a value greater then 1, you average the highest-high and the lowest-low over a number of %K Slowing Periods before performing the division.
A moving average of %K is then calculated using the number of time periods specified in the %D Periods. This moving average is called %D.
The Stochastic Oscillator always ranges between 0 percent and 100 percent. A reading of 0 percent shows that the security's close was lowest price that the security has traded during the preceding x time periods. A reading of 100 percent shows that the security's close was the highest price that the security has traded during the preceding x time periods.
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