Trade School: Understanding Stochastics Nick Fosco July 12, 2010

Stochastic – The Father Developer: George Lane Professional traders for 50+ yrs Floor Broker for 10 yrs BoD of Mid-America Commodity Exchange (1965) Wrote daily market letter/hot line for 16 yrs Trained thousands of traders on technical analysis since 1953 Passed in 2004 at age of 83 Source: Investopidia

The Stochastic Oscillator Is a technical momentum indicator Compares security’s closing price over a period of time Oscillator sensitivity is adjusted by changing the length of the time period. Higher sensitivity = shorter time period Higher sensitivity = less accuracy in buy/sell signals Theory: Trending markets tend to close at top or bottom end of daily price range for the respective upward or downward trend.

The Stochastic Formula %K = 100[(C - L14)/(H14 - L14)] C = the most recent closing price L14 = the low of the 14 previous trading sessions H14 = the highest price traded during the same 14-day period. %D = 3-period moving average of %K Alternative formula: (Slow Stochastic) %K = 100[(C - C14)/(H14 - L14)]

Stochastic Rules Works best as momentum ‘change’ indicator Indicator result is a normalized ratio 0 to 100 Overbought > 80 Oversold < 20 Buy: %K crosses %D after oversold condition Sell: %K crosses %D after overbought condition Best when used in conjunction with other supporting indicators such as: On Balance Volume Acceleration Bands Relative Strength

Examples Source: ThinkorSwim

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