Stochastic oscillator: A technical tool designed to

highlight shorter-term momentum and “overbought” and

“oversold” levels (points at which a price move has, theoretically

at least temporarily exhausted itself and is ripe for

a correction or reversal).

Calculation: The stochastic oscillator consists of two

lines: %K and a moving average of %K called %D. The basic

stochastic calculation compares the most recent close to the

price range (high of the range - low of the range) over a particular

period.

For example, a 10-day stochastic calculation (%K) would

be the difference between today’s close and the lowest low

of the last 10 days divided by the difference between the

highest high and the lowest low of the last 10 days; the

result is multiplied by 100. The formula is:

%K = 100*{(Ct-Ln)/(Hn-Ln)}

Ct is today’s closing price

Hn is the highest price of the most recent n days (the

default value is five days)

Ln is the lowest price of the most recent n days

The second line, %D, is a three-period simple moving

average of %K. The resulting indicator fluctuates between 0

and 100.

Fast vs. slow: The formula above is sometimes referred to

as “fast” stochastics. Because it is very volatile, an additionally

smoothed version of the indicator –– where the original

%D line becomes a new %K line and a three-period average

of this line becomes the new %D line –– is more commonly

used (and referred to as “slow” stochastics, or simply “stochastics”).

Any of the parameters –– either the number of periods

used in the basic calculation or the length of the moving

averages used to smooth the %K and %D lines –– can be

adjusted to make the indicator more or less sensitive to

price action.

Horizontal lines are used to mark overbought and oversold

stochastic readings. These levels are discretionary;

readings of 80 and 20 or 70 and 30 are common, but different

market conditions and indicator lengths will dictate different

levels.