The stochastic oscillator is a momentum indicator comparing the closing price of a security to the range of its prices over a certain period of time. The sensitivity of the oscillator to market movements is reducible by adjusting that time period or by taking a moving average of the result. The general theory serving as the foundation for this indicator is that in a market trending upward, prices will close near the high, and in a market trending downward, prices close near the low.
The stochastic oscillator was developed in the late s by George Lane. As designed by Lane, the stochastic oscillator presents the location of the closing price of a stock in relation to the high and low range of the price of a stock over a period of time, typically a day period. Lane, over the course of numerous interviews, has said that the stochastic oscillator does not follow price or volume or anything similar.
He indicates that the oscillator follows the speed or momentum of price. Lane also reveals in interviews that, as a rule, the momentum or speed of the price of a stock changes before the price changes itself.
In this way, the stochastic oscillator can be used to foreshadow reversals when the indicator reveals bullish or bearish divergences. This signal is the first, and arguably the most important, trading signal Lane identified.
Lane also expressed the important role the stochastic oscillator can play in identifying overbought and oversold levels, because it is range bound. This range — from 0 to — will remain constant, no matter how quickly or slowly a security advances or declines. Considering the most traditional settings for the oscillator, 20 is typically considered the oversold threshold and 80 is considered the overbought threshold.
However, the levels are adjustable to fit security characteristics and analytical needs. Readings above 80 indicate a security is trading near the top of its high-low range; readings below 20 indicate the security is trading near the bottom of its high-low range. Dictionary Term Of The Day.
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