When it comes to understanding the trending market, the Slow Stochastic Oscillator is a helpful component of any trading strategy. The oscillator works by comparing the difference between the closing trade price of an instrument and the period low relative to the trading range over an observation time period.
The Slow Stochastic
The Slow Stochastic Oscillator consists of two lines, known as the %K line and the %D line. Utilizing a range that falls between 0% and 100%, the %K line is calculated from the difference between the current closing price and the period low during specific time frames. That number is then divided by the difference between the period high (Highest High) and the period low (Lowest Low). The %D line represents a three day Moving Average of the %K line, and thus reacts less sensitively than the %K line.
Properties
%K: The number of periods in the chart. If the chart displays daily data, then %K Period denotes days; in weekly charts, the period will stand for weeks, and so on. The application uses a default value of 14.
%D: The number of periods used in the Moving Average calculation. The application uses a default of 3.
Smoothing Period: The number of periods used in the Moving Average calculation for the Slow Stochastic study. The application uses a default of 3.
Interpretation
The Slow Stochastic Oscillator is derived from the Stochastic study (SSTOC), which contrasts the difference between the closing trade price of an instrument and the period low relative to the trading range over an observation time period. With the help of this study, the position of the price quotation within the prevailing fluctuation margins is quantified.
Created by Dr. George C. Lane, the basic premise is as follows: during periods of price decreases, daily closes tend to accumulate near the extreme lows of the day. Periods of price increases tend to show closes accumulating near the extreme highs of the day. The Stochastic study is an oscillator designed to indicate oversold and overbought market conditions, helping participants spot certain trade signals, such as when to buy and sell, along with identifying the trending market.
The Stochastic study works similarly to the Relative Strength Index, although the Stochastic ranges between the values of 0% and 100%, and its overbought/oversold boundaries are wider, making this oscillator more volatile.
The Stochastic also generates two lines instead of one.
The Stochastic study has both overbought and oversold zones. Dr. Lane suggests using 80 as the overbought and oversold zones. Some traders, however, prefer 75 and 25.
Lane also contended that the most important signal is the divergence between %D and the contract. Divergence is the process where the Stochastic %D line makes a series of lower highs while the commodity makes a series of higher highs. This signals an overbought market. An oversold market exhibits a series of lower lows while the %D makes a series of higher lows.
When one of these patterns appears, traders should anticipate a market signal. Initiate a market position when the %K crosses the %D from the right-hand side. A right-hand crossover is when the %D bottoms or tops and moves higher or lower and the %K crosses the %D line.
According to Lane, the most reliable trades occur with divergence and when the %D is between 10 and 15 for a buy signal and between 85 and 90 for a sell signal.
Literature
Lane, Dr. George C. Stochastics. Trading Strategies Futures Symposium International. 1984.
Lane, Dr. George C. Lane’s Stochastics. Technical Analysis of Stocks and Commodities magazine. pp 87-90. May/June, 1984.
Murphy, John J. Technical Analysis of the Futures Markets. New York Institute of Finance. Englewood Cliffs, NJ. 1986.
Murphy, John J. The Visual Investor. New York, NY: John Wiley & Sons, Inc. 1996.
Le Beau C., Lucas D. W. Computer Analysis of the Futures Market. 1992.
Kaufman, Perry J. The New Commodity Trading System and Methods. 1987.
Content Source: FutureSource
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