Thursday, September 18, 2008
The Stochastic oscillator compares where a security’s price has closed relative to its price range over a specifically identified period of time. This is a predictive indicator in that it gives advance signals for buying and selling.
The indicator has been developed from the basic observation that prices tend to close near their high in an upward trending market and near their lows in a downward trending market. Further, as an upward trend matures, price tends to close further away from its high; and as a downward trend matures, price tends to close away from its low.
How is Stochastics Used ?
This indicator is often used to predict trend reversal. The indicator tries to determine when prices start to cluster around their low of the day for an up trending market, and when they tend to cluster around their high in a down trending market. Lane's theory is these are the conditions, which indicate a trend reversal is beginning to occur.
The stochastic indicator is plotted as two lines. They are the %D line and the %K line. The %D line is more important than the %K line.
The stochastic is plotted on a chart with values ranging from 0 to 100. The value can never fall below 0 or above 100. Readings above 80 are strong and indicate that price is closing near its high. Readings below 20 are strong and indicate that price is closing near its low.
A very powerful move is underway when the indicator reaches its extremes around 0 and 100. Following a pullback in price, if the indicator retests these extremes, a good entry point is indicated.
Ordinarily, the %K line will change direction before the %D line. However, when the %D line changes direction prior to the %K line, a slow and steady reversal is usually indicated.
When both %K and %D lines change direction, and the faster %K line subsequently changes direction to retest a crossing of the %D line, but doesn't cross it, this is a good confirmation of the stability of the prior reversal.
Many times, when the %K or %D lines begin to flatten out, this is an indication that the trend will reverse during the next trading range.
These are just some of the important and popular oscillators and indicators. There are many more. You need to study and pick the one that best suits your personality, apply the indicator and specialize to maximize profits.