Stochastic Oscillator

This oscillator was popularized by George Lane. It is based on the observation that in an uptrend closing prices tend to be in the upper end of the price range. Conversely, in a downtrend closing prices tend to be in lower end of the range. The intent of the oscillator is to determine the most recent closing price in relation the price range for a chosen period (which is usually 14 days on the daily chart or 14 weeks on the weekly chart). Two lines are used in the stochastics process %K line and a 3 period average of %K which is the %D line. The %D line is the more important one and provides the trading signals. The formula produces two lines that oscillate between 0 and 100.

How to use the Oscillator:

The signal to watch for is a divergence between the D line and the price of the underlying market when the D line is an overbought or oversold area. This is usually in the area of 80 and 20 respectively. A bearish divergence occurs when the D line is above 80 and forms two declining peaks while the market prices continue to move higher. A bullish divergence occurs when the D line is trading below 20 and forms two rising bottoms while the market prices continue to move lower.

The chart shows the weekly chart of SP500 index (from 2017 to 2019) with a 14 week Stochastic oscillator.

Two sets of buy and sell signals are observed on the oscillator.