Stochastics Buy & Sell Signals

How to Read a Stochastic Chart

In addition to giving clear buy and sell signals, the Stochastic technical analysis indicator is also helpful in detecting price divergences and confirming trend.

How to Read a Stochastic Chart

Buy Signal 

When the Stochastic is above the 80 overbought line and the %K line crosses below the %D line, sell.

There are two common ways to interpret these waves. The first is based on when the red and blue lines cross. A potential buy signal is generated when the blue line crosses above the red line, and a potential sell signal is generated when the red line crosses above the blue line.

Sell Signal

When the Stochastic is above the 80 overbought line and the %K line crosses below the %D line, sell.

The second way to translate these charts is based on a reading of the blue line (%K). When %K is at 20 or below, the stock is considered to be oversold . When %K goes above 20, the stock should be bought. On the other hand, when %K is at 80 or above, the stock is considered to beoverbought , and when %K goes below 80, the stock should be sold

Stochastics come in two flavors: fast and slow. Fast stochastics produce more buy and signals than slow stochastics, but some of the signals produced by fast Stochastics may be "false." Slow Stochastics produce fewer, but "stronger" signals.

Stochastic Fast

Stochastic Fast plots the location of the current price in relation to the range of a certain number of prior bars (dependent upon user-input, usually 14-periods). In general, stochastics are used to measure overbought and oversold conditions. Above 80 is generally considered overbought and below 20 is considered oversold. The inputs to Stochastic Fast are as follows:

• Fast %K: [(Close - Low) / (High - Low)] x 100
• Fast %D: Simple moving average of Fast K (usually 3-period moving average)

Stochastic Slow

Stochastic Slow is similar in calculation and interpretation to Stochastic Fast. The difference is listed below:

• Slow %K: Equal to Fast %D (i.e. 3-period moving average of Fast %K)
• Slow %D: A moving average (again, usually 3-period) of Slow %K

Stochastic Oscillator

1. Developed by George C. Lane in the late 1950s
2. Stochastic Oscillator is a momentum indicator that shows the location of the close relative to the high-low range over a set number of periods. 
3. Stochastic Oscillator "doesn't follow price, it doesn't follow volume or anything like that. It follows the speed or the momentum of price.
4. As a rule, the momentum changes direction before price." 
5. As such, bullish and bearish divergences in the Stochastic Oscillator can be used to foreshadow reversals. This was the first, and most important, signal that Lane identified. 
6. Lane also used this oscillator to identify bull and bear set-ups to anticipate a future reversal. 
7. Because the Stochastic Oscillator is range bound, is also useful for identifying overbought and oversold levels.

Setting

Calculation:

%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

The default setting for the Stochastic Oscillator 
is 14 periods, which can be days, weeks, months or
an intraday timeframe. A 14-period %K would use 
the most recent close, the highest high over the last
14 periods and the lowest low over the last 14 periods.
%D is a 3-day simple moving average of %K. This line is
plotted alongside %K to act as a signal or trigger line.

The theory behind this indicator is that in an upward-trending market, 
prices tend to close near their high, and during a downward-trending 
market, prices tend to close near their low. Transaction signals occur 
when the %K crosses through a three-period moving average called the 
"%D". 

Further reading : stockcharts.com