www.plindia.com | www.majorgainz.com KNOWLEDGE CENTRE Technical Analysis - Stochastic Oscillator Technical Indicators or Technicals refer to those indicators that are used to predict the future price levels or the general price direction of a stock or the index by looking at its past data. Common technical indicators include Relative Strength Index (RSI), Money Flow Index, Stochastic, MACD and Bollinger Bands. The most effective use of technicals for an investor is to help identify good entry and exit points for the stock by analyzing the long-term trend. The Stochastic Oscillator is a technical ‘momentum indicator’ that compares a script's closing price to its price range over a given period of time. The stochastic oscillator is a well-known momentum indicator used in technical analysis. The idea behind this indicator is that the closing prices should predominantly close in the same direction as the prevailing trend. In an upward trend the price should be closing near the highs of the trading range and in a downward trend the price should be closing near the lows of the trading range. When this occurs it signals continued momentum and strength in the direction of the prevailing trend. Stochastic Oscillator follows the speed or the momentum of the price. It is based on the assumption that by monitoring the price momentum we can anticipate where the prices are headed. It measures the level of the close price relative to its high-low range over a given period of time. The oscillator's sensitivity to market movements can be reduced by adjusting the time period or by taking a moving average of the result. (Moving Average is a technical indicator that shows the mean or average price of a stock over a certain period of time) The Stochastic Oscillator is displayed as two lines. The main line is called %K. The second line, called %D, is a Moving Average of %K. The %K line is usually displayed as a solid line and the %D line is usually displayed as a dotted line. You will generally see more distinct fluctuations in the %K line than in the %D line, because %D is moving average for the line %K. Stochastic indicator is measured on a scale from 0% to 100%. Reading the Chart The K line is the fastest and the D line is the slower of the two lines. The investor needs to watch as the D line and the price of the issue begin to change and move into either the overbought (over the 80 line) or the oversold (under the 20 line) positions. The investor needs to consider selling the stock when the indicator moves above the 80 level. Conversely, the investor needs to consider buying an issue that is below the 20 line and is starting to move up with increased volume. When the two lines intersect, i.e. when the price of the issue and the moving average intersect either above the 80% mark or below the 20% mark, one can assume it is aiming for a trend reversal. www.plindia.com | www.majorgainz.com KNOWLEDGE CENTRE There may be a situation where the indicator shows a fall, but the price continues to rise, this is called Negative Divergence. This signifies that the strength/momentum of the stock is weakening, and in most probability the price would fall in the near future. This can be seen in the above chart. The indicator shows a fall but does not fall below 80% staying at the highs of the trading range, while the prices rise to peak a little above 60, after which both the indicator and the prices make a lower low. The Stochastic Oscillator cannot be used by itself to determine the behavior of a particular stock, and cannot give an accurate decision whether to go short or long on a stock. This indicator has to be complimented with other indicators such as RSI or Bollinger Bands, in order to give an accurate determination of the stock and its levels. Karan Chimandas Kripalani +91 22 66322298 [email protected].