Stochastic Oscillator

The Stochastic is a momentum indicator devised by George Lane in the 1950's. It gives overbought or oversold signals depending on its position relative to the 0 level. The Stochastic can also be used to give convergence and divergence indications, such as when a stock/index price makes a new low however the Stochastic does not - this is a bullish divergence. Conversely when the stock/index price makes a new high but the Stochastic does not or moves horizontally this is a bearish divergence and the price of the stock/index will soon follow the Stochastic.

In general terms a Stochastic level below 20 would be considered oversold, where as a level above 80 would be considered overbought. However, Lane did not believe that a reading above 80 was necessarily bearish or a reading below 20 bullish. A buy or sell signal can be generated by the Stochastic when the indicator passes back above the 20 level for a buy signal or below the 80 level for a sell signal.

There are different types of Stochastic Oscillator and reference may be made to a Fast Stochastic or a Slow Stochastic. These are generated by using different settings - as detailed in the calculation below. The Fast Stochastic can be useful for quick trades - made in short time frames. The Slow Stochastic is more smoothed and loses a lot of 'noise' that can lead to confusion with the Fast Stochastic.