Fast Stochastic Oscillator

Overview

Stochastics are an oscillator. They consist of two curves called the %K line and the %D line, and are controlled through two parameters, n and m, specifying a number of periods. Both the %K and %D lines are plotted on a scale of 0 to 100. They measure where the closing price is in relation to the total price range of the selected number of periods.


Formula

The %K line is defined as follows:

%K = (CP - Ln) / (Hn - Ln) * 100

where CP = Latest Closing Price, n =  the number of periods, Ln = the Lowest ask price over the last n periods, and Hn = the Highest bid price over the last n periods.

The %D line is an m-period simple moving average of the %K line.


Parameters

Fast and slow stochastics only have two parameters:

  • n, specifying the number of periods to consider in the calculation of the %K line
  • m, specifying for the %D line the number of periods over which the %K line should be averaged.

Interpretation

Those that believe in this chart argue that as the closing prices tend to be close to the recent highs, in which case the lines are close to 100, then the market is overbought and a correction downwards is likely. Similarly, if the closing prices tend to be close to the recent lows, in which case the lines are close to 0, then the market is oversold and an upward correction is likely. Generally, the area above 70 or 80 indicate is considered an overbought region, while the area below 20 or 30 is considered an oversold region. Lines above 90 or 95 would (to the believers) identify a sell signal once they start to decline and lines below 5 or 10 identify a buy signal once they start to move up.

Others see a trading signal when the two lines cross in the overbought or oversold region. More specifically, they see a sell signal when a decreasing %K line intersects with the %D line in the overbought region, and they see a buy signal when an increasing  %K line intersects with the %D line in the oversold region.

Still others predict that prices will go up shortly if the %D line forms two rising bottoms is in the oversold region while the prices  continue to move lower. Conversely, the prediction is that prices will go up shortly if the %D line forms two declining peaks in the overbought region while prices continue to move higher.

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