what is a stochastic oscillator 
a stochastic oscillator is a momentum indicator comparing a particular closing price of a security to a 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 it is used to generate overbought and oversold trading signals utilizing a 0 100 bounded range of values investopedia jessica olahunderstanding the stochastic oscillatorthe stochastic oscillator is range bound meaning it is always between 0 and 100 this makes it a useful indicator of overbought and oversold conditions traditionally readings over 80 are considered in the overbought range and readings under 20 are considered oversold however these are not always indicative of impending reversal very strong trends can maintain overbought or oversold conditions for an extended period instead traders should look to changes in the stochastic oscillator for clues about future trend shifts stochastic oscillator charting generally consists of two lines one reflecting the actual value of the oscillator for each session and one reflecting its three day simple moving average because price is thought to follow momentum the intersection of these two lines is considered to be a signal that a reversal may be in the works as it indicates a large shift in momentum from day to day divergence between the stochastic oscillator and trending price action is also seen as an important reversal signal for example when a bearish trend reaches a new lower low but the oscillator prints a higher low it may be an indicator that bears are exhausting their momentum and a bullish reversal is brewing the stochastic oscillator is only one of several technical indicators used by option traders to time entry and exit points image by sabrina jiang investopedia 2021formula for the stochastic oscillator k c l14 h14 l14 100 where c the most recent closing price l14 the lowest price traded of the 14 previous trading sessions h14 the highest price traded during the same 14 day period k the current value of the stochastic indicator begin aligned text k left frac text c text l14 text h14 text l14 right times100 textbf where text c the most recent closing price text l14 the lowest price traded of the 14 previous text trading sessions text h14 the highest price traded during the same text 14 day period text k the current value of the stochastic indicator end aligned k h14 l14c l14 100where c the most recent closing pricel14 the lowest price traded of the 14 previoustrading sessionsh14 the highest price traded during the same14 day period k the current value of the stochastic indicator notably k is referred to sometimes as the fast stochastic indicator the slow stochastic indicator is taken as d 3 period moving average of k 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 transaction signals are created when the k crosses through a three period moving average which is called the d the difference between the slow and fast stochastic oscillator is the slow k incorporates a k slowing period of 3 that controls the internal smoothing of k setting the smoothing period to 1 is equivalent to plotting the fast stochastic oscillator 1history of the stochastic oscillatorthe stochastic oscillator was developed in the late 1950s 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 prices of the stock over a period of time typically a 14 day period lane over the course of numerous interviews has said that the stochastic oscillator does not follow price volume or anything similar he indicates that the oscillator follows the speed or momentum of price lane also reveals that as a rule the momentum or speed of a stock s price movements changes before the price changes direction 2 in this way the stochastic oscillator can foreshadow reversals when the indicator reveals bullish or bearish divergences this signal is the first and arguably the most important trading signal lane identified example of the stochastic oscillatorthe stochastic oscillator is included in most charting tools and can be easily employed in practice the standard time period used is 14 days though this can be adjusted to meet specific analytical needs the stochastic oscillator is calculated by subtracting the low for the period from the current closing price dividing by the total range for the period and multiplying by 100 as a hypothetical example if the 14 day high is 150 the low is 125 and the current close is 145 then the reading for the current session would be 145 125 150 125 100 or 80 by comparing the current price to the range over time the stochastic oscillator reflects the consistency with which the price closes near its recent high or low a reading of 80 would indicate that the asset is on the verge of being overbought relative strength index rsi vs stochastic oscillatorthe relative strength index rsi and stochastic oscillator are both price momentum oscillators that are widely used in technical analysis while often used in tandem they each have different underlying theories and methods the stochastic oscillator is predicated on the assumption that closing prices should move in the same direction as the current trend meanwhile the rsi tracks overbought and oversold levels by measuring the velocity of price movements in other words the rsi was designed to measure the speed of price movements while the stochastic oscillator formula works best in consistent trading ranges in general the rsi is more useful during trending markets and stochastics more so in sideways or range bound markets 3limitations of the stochastic oscillatorthe primary limitation of the stochastic oscillator is that it has been known to produce false signals this is when a trading signal is generated by the indicator yet the price does not actually follow through which can end up as a losing trade during volatile market conditions this can happen quite regularly one way to help with this is to take the price trend as a filter where signals are only taken if they are in the same direction as the trend 