Stochastic Oscillator (Fast) Study

By Samantha Baltodano

TL;DR:

The Stochastic Fast study is based on the premise that a security’s price will be near an upper price range when it is overbought and it will approach a lower price range when it is oversold.

The Stochastic Fast value represents the current price of a security in relation to the security’s recent price range.

What Is Stochastic Fast?

The Stochastic Fast study is a momentum oscillator based on the observation that in an uptrending market, prices tend to close near the upper end of the price range. In downtrends, close prices are often seen approaching the lower end.

The oscillator is made up of two lines set at a predetermined maximum and minimum value. The space between these two lines should contain all price movement. The distance between the upper and lower lines is 0-100%.

Formula for the Stochastic Oscillator

%K = (C - L14 / H14 - L14) * 100

where:

C = the most recent close price

L14 = The lowest price traded of the 14 previous trading sessions

H14 = The highest price traded during the sam 14-day period

%K = The current value of the stochastic indicator

Notably, %K is referred to as the fast stochastic indicator. The slow stochastic indicator is taken as %D = 3-day average of %K

The stochastic oscillator does not follow price, volume, or anything similar. It instead follows the speed or momentum of price.

K represents the current price in relation to the security’s recent price range.

The momentum or speed of a stock’s price movements changes before the price changes direction. As a result, the stochastic oscillator is a tool for foreshadowing reversals when the indicator reveals bullish or bearish divergences.

Example

As an example, if the 14-day high is $100, the low is $80, and the current close is $95, then the stochastic value is: 

(($95 - $80) / ($100 - $80)) * 100 = 75%

By comparing the current price to the range over time, the stochastic oscillator assesses the consistency with which the price closes near its recent high or low prices. A reading of 80% would indicate that the security is on the verge of being overbought.

Limitations

The 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, but 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.

Buy and Sell Triggers

Buy and sell signals are based on the Stochastic Crossover Study.

When the Stochastic Fast Oscillator crosses above the overbought threshold of 80, then crosses back below the threshold, this is a signal to sell.

When it crosses below the oversold level of 20, then crosses back above this threshold, this is a signal to buy.

Summary

• Stochastic oscillators vary around a mean price level since they rely on a security’s price history.
• Stochastic oscillators measure the momentum of a security's price to determine trends and predict reversals.
• Stochastic oscillators measure recent prices on a scale of 0 to 100, with measurements above 80 indicating that a security is overbought and measurements below 20 indicating that it is oversold.
• The standard time period used is 14 days, but this can be adjusted to meet specific analytical needs.

Stochastic Fast is just one of many studies that Archaide automates. For a full list of strategies and studies available click here.

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