How to use Stochastic Oscillator in trading

Developed by George C. Lane in the late 1950s, the Stochastic Oscillator is a momentum indicator that shows the location of the close relative to the high-low range over a set number of periods. According to an interview with Lane,

The Stochastic Oscillator "doesn't follow price, it doesn't follow volume or anything like that. It follows the speed or the momentum of price.As a rule, the momentum changes direction before price." As such, bullish and bearish divergences in the Stochastic Oscillator can be used to foreshadow reversals. This was the first, and most important, signal that Lane identifie dBecause the Stochastic Oscillator is range bound, is also useful for identifying overbought and oversold levels.

CALCULATION

%K = (Current Close - Lowest Low) / (Highest High - Lowest Low) * 100
%D = 3-day Simple Moving Average (SMA) of %K
Lowest Low = Lowest Low for the look-back period
Highest High = Highest High for the look-back period
Note: %K is multiplied by 100 to move the decimal point two places
The default setting for the Stochastic Oscillator is 14 periods, which can be days, weeks, months or an intraday timeframe. A 14-period %K would use the most recent close, the highest high over the last 14 periods and the lowest low over the last 14 periods. %D is a 3-day simple moving average of %K. This

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