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Stochastic Oscillator

Definition:
The Stochastic Oscillator compares the last closing price of a security with its price range over a specific time period.

It is displayed as two lines where the main line (%K) is displayed in light blue (The legend also indicates the number of days on which the calculations are based), and the second line (%D) is displayed in dark blue. The %D displays the Buy / Sell signals.

- %K is based on a moving average of the highs and lows of the n last days.
- %D is based on a moving average of the %K on the last n days.

where n is the number of days determined in the preferences.


Why use the Stochastic Oscillator
Detect buy and sell signals as well as changes in trends.

Analysis methods for the Stochastic Oscillator

The result of the calculations are measured as a percentage and plotted on a scale from 0 to 100 below the main chart.

A result for %K above 80 indicates the price of the share being analysed is near the top of the total price range. A result for %K below 20 indicates the price of the share being analysed is near the bottom of the total price range.

Buy Signals :
- A Buy signal is indicated when the %K or %D fall below and then rises above the 20 point level.
- A Buy signal is indicated when the %K line rises above the %D line.

Sell signals :
- A Sell signal is indicated when the %K line falls below the %D line.
- A Sell signal is indicated when the %K or %D rise above and then fall below the 80 point level.

Detecting Trend Changes:
- When prices are making new highs and the Stochastic Oscillator does not exceed its previous highs, a divergence occurs, indicating a probable change in trend.

Detailed analysis, interpretation and preferences
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If we take for example the Chart for Richemont (CFR), we can clearly see the Buy and Sell signals when the %K and %D cross each other and are situated above and below the limits stated above.

Notice the %K that crosses below the %D on Friday October 6 and that both the moving averages are situated above the 80 limit, this signal indicates a clear Sell. Further on (October 17) both moving averages are situated below the 20 limit line and the %K crosses over the %D, which indicates a Buy situation.


These situations are true for the %K and %D set at three day periods each (Preference settings) and the Stochastic period set at 14 days. These settings are the most widely used by professionals.

As a general rule the Stochastic Oscillator will display a crossing while the instrument is showing new highs or lows. This is clear if we look closely at the calculation methods which are the following :

Preference Settings :

    Stochastic %K period = 3 days
    Stochastic %D period = 3 days
    Stochastic period = 14 days
    H14 = 14 day high
    L14 = 14 day low

    - %K3 (day t)

    [Average (close (t), close (t-1), close (t-2)) – Average (L14 (t), L14 (t-1), L14 (t-2)) ]
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    [Average(H14 t, H14 t-1, H14 t-2) - average (L14 t, L14 t-1, L14 t-2) ]

    - %D3 (day t)

    Average [(%K3 (t), %K3 (t-1), %K3 (t-2)]

Tips & Tricks
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You have to be aware of the fact that the trend may inverse itself and thus give you the opposite indications or may be just the beginning of a long fall in the share price. An easy method to avoid this weak point is to analyse the security using the Stochastic Oscillator and as a support use the RSI indicator and the Williams %R. In a Bull market, these indicators are extremely reliable for investment decisions and strategies.


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