STOCHASTICS

Stochastics indicator in technical analysis of stock market relates to the measurement of the price close of a security relative to its price range over a given period of time. The Stochastic Oscillator is displayed as two lines called %K and %D. The main line is called %K which is usually displayed as a solid line and the second line, called %D, is a moving average of %K which is usually displayed as a dotted line.

Expressed as a percentage 100 % shows the highest point and 0 the lowest point. Considering a time period of 14 days for a particular stock and the 14 day high is Rs. 100 and Rs. 90 is the 14 day low then these two form the highest and lowest points. Current price of Rs. 95 indicates the %K stochastic as 50.

Closing levels that are consistently near the top of the range indicate accumulation of the security (buying interest) and those near the bottom of the range indicate distribution of the security (selling pressures).

CALCULATION OF STOCHASTICS

The Stochastic Oscillator has four variables:

%K periods. This is the number of time periods used in the calculation

%K Slowing Periods. This value indicates the internal smoothing of %K. A value of 1 is considered as a fast stochastic and a value of 3 is considered as a slow stochastic

%D periods. This is the number of time periods used when calculating a moving average of %K.

%D method. The method (i.e., Simple, Exponential, Smoothed, or Weighted) that is used to calculate %D.

The formula for %K is:

%K = (Close-Low(%K))/(High(%K)-Low(%K))*100

Here

Close means the day’s closing price

Low(%K) means the lowest low in %K periods

High (%K) means the highest high in %K periods

The %D moving average is calculated as %D= Simple Moving Average(%K, n) where n is the smoothing period

There are three types of Stochastics : Fast, Slow and Full. The first two are mostly used by the technical analysts.

Normally the Interpretation is made as follows :

Buy a security when the Stochastics Oscillator (either %K or %D) goes below a specific level (Popularly 20 is followed) and then rises above that level. Sell a security when the Oscillator rises above a specific level (Popularly 80 is followed) and then falls below that level.

Buy a security when the %K line rises above the %D line and sell a security when the %K line falls below the %D line.

Divergences are also used to identify a buy or a sell signal. If the price is making a lower low, but the stochastic is making a higher low, some analysts interpret it as a buy signal and vice-versa.