MetaStock Stochastic Oscillator Function

The Stochastic Oscillator is another popular oscillator that is widely used. The premise behind its calculation is that when a security is rising, it tends to close near the high of a recent period and a falling security closes near its low. So, the Stochastic actually measures the price of a security relative to the high/low range over a set period of time. Thus it provides an indication of where the security is presently trading within its recent trading range.

CALCULATION

The formula for the Stochastic Oscillator (%K) is

In the above formula:

C = Present closing price L_n = Lowest low for the last `n' periods

H_n = Highest high for the last `n' periods n = number of periods used in calculation

The indicator itself oscillates between 0 and 100, with readings below 20 considered oversold and readings above 80 considered overbought. As such, this indicator lends itself well to positive/negative divergences.

SYNTAX Stoch(%k Periods, %k Slowing)

%k Periods _ This will determine the recent trading range that is used in the calculations.

%k Slowing _ To help smooth out the %K line, a slowing factor can be used. The slowing factor will take the last `x' number of periods and average the closing prices from all those periods. This helps remove an erratic behaviour from the oscillator.

Note: Another line which is commonly used in conjunction with the %K is called the %D line. MetaStock does not have a custom %D line within its functions, however, the %D line is simply a moving average of the %K line. Therefore if we wish to use the %D line, we will need to use the following:

Mov(Stoch(%k Periods, %k Slowing),3,S)

EXAMPLE

Here is an example using the Stochastic Oscillator:

Stoch(8,3)

In the above example:

%k periods = 8

%k slowing = 3 

APPLICATION

A more useful application of this example could be:

Stoch(8,3)>20 AND Ref(Stoch(8,3),-1)<20 {This could also be achieved with the Cross function)

This formula specifies that the present value of the stochastic oscillator is to be above the 20 reference line, and that the previous period's value to be less than 20. The other common reference line is normally set at 80. A basic strategy with the Stochastic Oscillator is to go long when the Stochastic crosses above the 20 reference line and to go short when it crosses below the 80 reference line.

Looking at Figure 3.33, we can see the Stochastic Oscillator indicator at the base of the chart

  
 

Figure 3.33 _ Stochastic Oscillator Indicator    

EXERCISES

Construct formulas for the following:

1. The Stochastic Oscillator (using 8 periods and a slowing factor of 3) is above the %D line:

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2. The Stochastic Oscillator (same as above) crosses above the %D line and the %K line is below 20:

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