The Stochastic Oscillator (SO) (pronounced sto kas’tik) is a momentum indicator that was developed in the 1950’s by a group of futures traders in Chicago. Primarily attributed to Dr. George Lane (1921 – July 7, 2004) it is sometimes referred to as ‘Lane’s stochastics’. The term stochastic refers to the location of the current price in percentage terms relative to it’s range over a specific period.
“Stochastics measures the momentum of price. If you visualize a rocket going up in the air; before it can turn down, it must slow down. Momentum always changes direction before price.” – Dr. George Lane
Interpreting the Stochastic Oscillator
Because of Lane’s belief that momentum changes direction before price, he looked for bullish and bearish divergences as a warning of pending reversals.
Another method is to only take positions when the Stochastic Oscillator is within a specific range. e.g Only going long when the SO is above 80 (meaning a stock is with within the top 80% of its range over the specified period).
Active traders may choose to trade the SO directly from its signal line. e.g go long when the %K line rises above the %D line.
Below is a Slow Stochastic Oscillator with the most commonly used settings of N(14), %K(3) and %D(3):
How to Calculate the Stochastic Oscillator
%K = 100 * ( Average(CL,s) / Average(HL,s) )
%D = User selected moving average of %K.
Were:
s = User Selected smoothing period.
CL = Close – Low(n)
HL = High(n) – Low(n)
n = User selected look back period for measuring the price percentage range.
Notes:
An ‘s’ of 1 will produce a ‘Fast Stochastic’ while a setting of 3 is typicality used for a ‘Slow Stochastic’. Interestingly the Williams %R is identical to the %K but mirrored at the 0% line.
Free Stochastic Oscillator Excel Download
We have built a free Excel Spreadsheet for you to download containing an SO that will automatically adjust to the settings you choose. You will find it at the following link under Technical Indicators.
Is the Stochastic Oscillator a good indicator?
As part of the Technical Indicator Fight for Supremacy we putting it to the test through 300 years of data across 16 different global markets – See the results.