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Fast Stochastic Oscillator

Implication Description %K %D Trading Considerations

Implication

Recognia identifies an event for a fast stochastic oscillator when:

  • Bullish: %K and %D lines fall below and then rise above the 20 threshold, indicating bullish potential, along with a %K line cross above the %D line, triggering a bullish signal event if these 3 crossovers occur within a 5-day period.
  • Bearish: %K and %D lines rise above and then fall below the 80 threshold, indicating bearish potential, along with a %K line cross below the %D line, triggering a bearish signal event if these 3 crossovers occur within a 5-day period.

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Description

The fast stochastic oscillator compares two lines called the %K and %D lines to predict the possibility of an uptrend or a downtrend. In price charts, the %K line typically appears as a solid line, and the %D line appears as a dotted line. The fast stochastic oscillator can be used effectively to monitor daily, weekly or monthly periods.

According to Martin J. Pring, George Lane developed the stochastic oscillator with the premise that during an uptrend, the closing price tends to rise. However, when the uptrend matures, price tends to close towards the bottom of the price range for the period. Likewise, in a downtrend, the reverse holds true.

The difference between the fast and slow stochastic oscillators is the way that the %K and %D values are calculated. Slow stochastics are based on the moving averages values calculated for fast stochastics. As such, John J. Murphy writes that most traders favor slow stochastics because they tend to be more reliable.

Fast Stochastic

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%K

For fast stochastics, the %K value is calculated as follows:

%K = 100 [(C-L)/(H-L)]

Where
C is the latest closing price of the stock
L is the lowest price of the stock for the period that you are monitoring. Recognia uses a 14-day period as the period to monitor.
H is the highest price of the stock for the period that you are monitoring. Recognia uses a 14-day period as the period to monitor.

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%D

For fast stochastics, the %D value is based on a 3-period moving average of the %K value. The %D value is calculated as follows:

%D = 100 x (H-L)

Where
H is the sum of C-L in the last three periods
L is the sum of H-L in the last three periods

Pring identifies that a way to differentiate the %K line from the %D line is to remember that %K represents "Kwick" movements, while %D shows movements that "Dawdle". As such, Edwards and Magee note that "[ordinarily], the %K Line will change direction before the %D Line. However, when the %D line changes direction prior to the %K line, a slow and steady Reversal is often indicated."

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Trading Considerations

This section identifies that inform trading decisions using stochastics. It should be pointed out, that many technical analysts use stochastics in combination with other patterns or oscillators. John J. Murphy, for example, suggests that "[one] way to combine daily and weekly stochastics is to use weekly signals to determine the market direction and daily signals for timing. It's also a good idea to combine stochastics with RSI."

When you are using stochastics with price charts, keep the following factors in mind:

  • Extremes
    When the %K line nears the 100% or 0% line a powerful move is set to occur. Some technical analysts equate the extremes with overbought or oversold conditions, and that prices cannot get any higher or lower. However, Edwards and Magee identify that this is not true in all situations, and that the extremes instead represent the strength of a price move.
  • Divergences
    A divergence is said to have occurred when the price and oscillator trend lines move in different directions. A price reversal may follow.
  • Hinges
    Lane referred to a flattened %K or %D line as hinges. A hinge may indicate that the uptrend or downtrend has become exhausted, and that a price reversal may occur.
  • Crossovers
    When the price has reached 80 or higher, and a divergence has occurred, a crossover is the sell signal. To summarize Lane, Robert W. Colby writes that "the sell signal is more reliable when %D has already turned down when %K crosses below %D"."

    Similarly, when the price has reached 20 or lower, and a divergence has occurred, a crossover becomes the buy signal. Robert W. Colby writes that "the buy signal is more reliable when %D has already up down when %K crosses above %D"."