Stochastic (14, 3, 3) (STOCH)
Stochastic Oscillator (STOCH) is a range bound momentum oscillator. The Stochastic indicator is designed to display the location of the close compared to the high/low range over a user defined number of periods.
Stochastic Oscillator is used to: (1) Identify overbought and oversold levels (2) find divergences and (3) identify bull and bear set ups or signals.
STOCH is a range-bound oscillator consisting of two lines that move between 0 and 100. The first line (known as %K) displays the current close in relation to a user-defined period’s high/low range. The second line (known as %D) is a simple moving average of the %K line. Now, as with most indicators, all of the periods used within Stochastic can be user defined. That being said, the most common choices are a 14 period %K and a 3 period SMA for %D.
The basic understanding is that Stochastic uses closing prices to determine momentum. When prices close in the upper half of the look-back period’s high/low range, then the Stochasitc Oscillator (%K) rises also indicating an increase in momentum or buying/selling pressure. When prices close in the lower half of the period’s high/low range, %K falls, indicating weakening momentum or buying/selling pressure.
Much like with any range-bound indicator, Overbought/Oversold conditions are a primary signal generated by the Stochastic Oscillator. The default thresholds are 20 for oversold and 80 for overbought.
It is typically best to trade along with the trend when using Stochastic to identify overbought/oversold levels. The reason is that overbought does not always mean a bearish move just like oversold does not always mean a bullish move. Many times overbought (oversold) conditions can be a sign of a strengthening trend and not necessarily an impending reversal.
The Stochastic Oscillator is usually plotted with a 3-day simple moving average that acts as the trigger line. When the Stochastic Oscillator crosses above the trigger line it is a bullish moving average crossover, and when it crosses below it is bearish.