Stock Technical Analysis – Stochastic Oscillator

  • Type: momentum oscillator
  • Data requirement: daily high-low-closes for individual stock
  • Inputs
    • look back period: no. of periods (n) to use (suggested default is 14)
    • smoothing period: no. of periods (m) for smoothing %K (suggested default is 3)
    • moving average period: no. of periods (l) for SMA (suggested default is 3)
  • Formulas
    • Fast Stochastic (n=14, m=1, l=3)
      • Fast %K = (Current Close – Lowest Low in past n periods) / (Highest High in past n periods – Lowest Low in past n periods) * 100
      • Fast %D = 3-day SMA for Fast %K
    • Slow Stochastic (n=14, m=3, l=3)
      • Slow %K = 3-day smoothed Fast %K
      • Slow %D = 3-day SMA for Slow %K
    • Full Stochastic (n, m, l being arbitrary)
      • Full %K = m-day smoothed Fast %K
      • Full %D = l-day SMA for Full %D
  • Signals
    • Oversold: below 20
      • It is often to observe frequent oversold readings in bearish trend.  So look for occasional overbought readings in such a bearish trend instead.
    • Overbought: above 80
      • It is often to observe frequent overbought readings in bullish trend.  So look for occasional oversold readings in such a bullish trend instead.
    • Reversal: stay in oversold / overbought zone and then leave the zone.
    • Divergences are not confirmation signals.  Could be confirmed by support / resistance breaks.
    • 3-step confirmation pattern
      • signal lines crossover (%K crossing %D) or zone crossover (moving above 20 from oversold zone or moving below 80 from overbought zone)
      • centerline (50) crossover
      • resistance / support break in price chart
  • c.f. http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:stochastic_oscillato
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