Stochastic Oscillator indicator, also known as the KDJ indicator, was first created by George Lane and was initially used in the futures market. It is used to measure the momentum of an asset’s price within a certain period. The details are as follows:
Basic Principle
The Stochastic Oscillator is based on an assumption. In an uptrend, the price tends to remain at a relatively high position for a period of time. In a downtrend, the price tends to remain at a relatively low position for a period of time. It judges the overbought/oversold situation of the market and the strength of the trend. It does this by comparing the current price with the relative position within the price range of a certain period.
Calculation Method of Stochastic Oscillator
The Stochastic Oscillator usually consists of two lines: the %K line and the %D line.
The calculation formula for the %K line is rather complex. Generally, it is calculated as follows:
%K = (C-Ln)/(Hn-Ln)*100
Here, C is the current closing price. Ln is the lowest price within the selected time period. and Hn is the highest price within the selected time period.
The %D line is the moving average of the %K line. Usually, a 3 – day simple moving average is used. That is:
%D = MA(%K, 3)
Indicator Interpretation
Overbought/Oversold Areas
When the value of the Stochastic Oscillator exceeds 70, the market is considered to be in an overbought state. This may mean that the price is about to fall. It is a signal to sell.
When the value of the Stochastic Oscillator is below 30, the market is considered to be in an oversold state. This may mean that the price is about to rise. It is a signal to buy.
Crossover Signals
When the %K line crosses the %D line from below upwards, it is called a “golden cross”. This is usually regarded as a buy signal. It indicates that the upward trend of the market may strengthen.
When the %K line crosses the %D line from above downwards, it is called a “death cross”. This is usually regarded as a sell signal. It indicates that the downward trend of the market may strengthen.
Precautions for Application
It is relatively sensitive to short-term price fluctuations. It may generate many false signals. Investors need to use it with caution.
The Stochastic Oscillator may perform differently in different markets and time frames. It is necessary to combine other technical analysis tools and fundamental analysis. This is to comprehensively judge the market trend.
Reproduction Notes：InvestFancy » Stochastic Oscillator