Introduction to Stochastic
Stochastic, as a stochastic oscillator indicator is often simply called, is a momentum indicator that shows the price sensitivity of a security to time over which the price sensitive was measured. It shows overbought and oversold levels by analyzing the price history of a security with its closing price on a day.
Understanding Stochastic
Like many other technical analysis tools, stochastic indicator is not a singular depictor and is often strongly associated with relative strength index (RSI). It does not calculate the price; it calculates the speed at which the price is moving that shows the interpretation to investors whether it might be a good time to sell or buy the stock. This works on the logic that before there is a change, there is a slight hitch in the movement that can be called the momentum of the stock price. It is near that hitch that the stochastic indicator will point to, helping keen investors find a price at which the trend line may shift. This space also serves as the buy or sell signal. The theory notes that if the market is trending upward, the prices will close at the high and vice versa; the exact possible price at which the change may occur can be calculated using %K and %D. Simply put, a stochastic indicator will take the highest price and the lowest price in the 14 day window and compare it to the present day’s closing price.
Highlights of Stochastic Indicator
To make sense of the stochastic indicator, a 14 day default period of study is necessary. No matter what time of study it is—weeks, last 14 hours, days or months. This period defines the %K line that is usually referred to as the fast stochastic. The %D line is slow stochastic that follows the Simple Moving Average of the previous 3 days of price movement or just SMA of the %K line. The D line acts as the trigger or signal line that is used alongside the %K line to plot the smallest changes. Stochastic indicator is an oscillator and swings between 0 and 100. If the number is 80, then the stock is overbought and if it’s 20, the stock is undersold. It is not a strong predictor by itself.
