STOCHASTIC

Stochastics are another type of oscillator widely used by many technicians, and developed by George Lane. They are a form of oscillator which place significance on where the closing price is, relative to the high and low for the period. The theory behind stochastics is simple. Rising prices are often accompanied by closes near the highs of the range, while falling prices are often accompanied by closes near the lows of the range. Prices which close near the middle of the range suggest a listless or trend less market.

The %D value is simply the moving average of the %K value. The moving average can be calculated in any way such as the simple or exponential calculation. The equation for the simple moving average calculation is:

The %K value reacts more quickly, or is "faster", than the %D value, because the %D value is a moving average of the %K value. The stochastics can be varied to give faster or slower signals just like a moving average.

Stochastic values below 30% suggest the market is oversold, whereas values above 70% imply the market is overbought. Many types of rules can be developed to trade with stochastics. For example, one rule is to sell when the fast (%K) crosses the slow (%D), and both are pointing down but above the 70% level. A buy signal would be generated when the fast crosses the slow, and both point up but are below the 30% level. These rules did not provide many good sell signals in 1990 because the market was in a strong uptrend, but a good sale could have been made in February. A good buy signal was generated in early March. Another type of signal occurs when the stochastic confirms, or diverges, from a price move similar to the moving average oscillator rules.