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.
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.
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.