The stochastic oscillator is based on the assumption that as prices increase, closing prices tend to be closer to the high and vice versa. The indicator value expresses where the most recent close is in relation to the range of a chosen time period (14 is common) on a percentage basis (0 to 100). The indicator consists of two lines: |
• %K = 100 x ((Close - L14) / (H14 - L14))
• L14 = the lowest low of the last 14 bars
• H14 = the highest high of the last 14 bars
• %D = a moving average of %K
Another moving average of %D provides an even smoother line that is called slow stochastics
A reading above 80 indicates an overbought market - a cross below 80 signals a sell. A reading below 20 indicates an oversold market - a cross above 20 signals a buy. Divergence at extremes signal reversal opportunities.