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Stochastic Indicator

All traders try to use the right tools to be able to achieve very precise analysis techniques, in order to reduce their risk as much as possible and at the same time trying to maximize their profits.

Among the indicators used by traders surely we can include the Stochastic indicator. The Stochastic indicator has been developed by George Lane and it’s an indicator of momentum that graphically represents the closing price compared to maximum and minimum prices in a determined period. The stochastic indicator can assume a value between 0 and 100 depending on whether the trend is approaching, minimum or maximum. This indicator can be used in each time-frame including the weekly, daily and even intraday.

The graphical representation of the Stochastic is very simple and it’s possible to implement it through the various technical analysis software, which almost always include this indicator as tool available to the trader.

stochastic

The stochastic is represented by two curves:

1) % K that graphically represents the maxima and minima.

2) %D which is calculated through the use of the exponential moving average % K with the purpose of avoiding false signals.

The first step for the calculation of the indicator is to calculate the Stochastic % K applying the following formula:

%K = (C – Ln/Hn- Ln) *100

Where:

C= closure price

Ln= Minimum determined period

Hn= Maximum period

n= number of selected days in order to apply the stochastic indicator.

The second step concern how to calculate %D  which is obtained by smoothing the % K, usually using a three-day period.

%D= [sum period(C – Ln)/sum period(Hn-Ln)]*100

In the graphs of the indicator stochastic we can identify two areas that coincide with the steps of:stochastic-oversold-overbought-levels

1- Oversold, or a market situation in which the indicator falls to below 20;

2- Overbought , for example a situation in which the indicator rises above 80.

In fact there are two different types of stochastic indicators that differ in their sensitivity to price changes:

1-     Fast stochastic, which is represented by the two curves % K and % D plotted on the same graph and that is very sensitive to changes prices;

2-     Slow Stochastics, which is obtained by calculating a moving average period % K. Through this change, it’s possible to eliminate false trading signals.

The practical use by the trader may not be immediate, that’s why you need a good workout and an additional evaluation with other indicators.

To get more information on the operation of the indicator stochastic and other technical analysis tools, our experts will be happy to provide you all the necessary information.

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