Stochastic momentum index: What is this, How It Works

What Is a stochastic momentum index?

stochastic momentum index The sensitiveness of the oscillator to fluctuations in market prices can be decreased by adjusting the time interval or taking the movement mean of the results. This is utilized to generate signals for overbought or oversold signals for trading by using an 0-100-bounded value range.

Understanding the stochastic momentum index

 This makes it an excellent indicator of overbought and undersold conditions.

Generally, readings above 80 are thought to be as being in the range of overbought and readings that are less than 20 are considered to be oversold. However, these readings aren’t always a sign of imminent reversal or a change in trend; strong ones can keep overbought or oversold levels for a longer time. It is better to pay attention at the fluctuations of the stochastic oscillator as indications of future trends.

The charting of stochastic momentum index oscillators typically comprises two lines, one indicating what the value actually is of the oscillator in each session, and another that shows its three-day simple average. Since price is believed to be a function of the momentum and the line that intersects these two lines can be thought as a signal there is a reversal taking place, since it signifies a significant shift in the direction of stochastic momentum index from day to the next day.

The divergence in the stochastic momentum index oscillator and the trending price action can be viewed as a significant reversal signal. In the case of example, if the bearish trend makes an all-time low however, the oscillator shows an upper lower low, it could indicate that bears are exhausted by their energy and there is a possibility of a bullish reversal.

Formula for the stochastic momentum index

In addition, %K is often frequently referred to as the rapid stochastic indicator. This “slow” stochastic index can be considered to be %D as the 3-period moving mean of %K.

The basic theory that forms the base to this indicator states that when a market is that is trending upwards, prices close close to the top when compared to an economy that is trending downwards prices will close near the lowest. Transparency signals are generated when the %K passes through an average of three periods, that is known as the %D.

The major difference in the speed and slow Stochastic Oscillator is that the slow %K has a slowing period of three that regulates the smoothing process inside the %K. Setting the smoothing duration to 1 is the same as creating fast stochastic Oscillator.1

History of the stochastic momentum index

This stochastic oscillator invented in the latter half of 1950 in the late 1950s by George Lane. According to Lane the stochastic oscillator shows the position that the price at which a stock closes stock relation to the low and high prices that the share has over a certain period of time, usually 14 days.

Lane in several interviews, has stated in numerous interviews that stochastic oscillation doesn’t follow volume, price or any like that. The oscillator is influenced by the pace or speed of price.

Lane further reveals that generally the speed or momentum that a price fluctuations alters prior to the price changing direction.2 In this manner the stochastic oscillator may be a good indicator of reversals if it shows bearish or bullish divergences. This is the very first, and possibly the most significant, trading signal Lane discovered.

Example of the stochastic momentum index

The stochastic oscillator can be found in the majority of charting tools, and is a simple tool to use in the real world.

For a hypothetical example in a hypothetical scenario was $150 and the lowest is $125, and the current closing is $145, the reading for the present session would be: (145-125) * (150 + 150 – 125) * 100 or 80.

In comparing the current price to the range of prices over time the stochastic oscillator shows the regularity that the price is closing within its current highest or lowest. If the reading is 80, it could suggest that the asset is in the process of being overbought.

Relative Strength Index (RSI) against. stochastic momentum index

It is the relatory strength index (RSI) as well as stochastic oscillator are both momentum oscillators which are extensively employed to analyze technical data. Although they are usually employed in conjunction both possess their own methods and theories. The stochastic oscillator rests on the idea that closing prices follow the same trend according to the trend is currently.

In addition, the RSI monitors the overbought as well as the oversold levels by analyzing the speed of price movements. Also it is the RSI was developed to determine the speed at which price fluctuations occur as well as its stochastic oscillator model performs excellent when trading in a consistent range.

In general generally, the RSI is a better opportunity in market trends and stochastics better in range-bound or sideways markets.3

Limitations of the stochastic momentum index

The main drawback for the stochastic oscillator is that it has been proven to create fake signals. It happens the case when a signal for trading comes from the oscillator, however the price does not follow through, and could result in a loss trade. In times of volatility it can happen frequently.

What Does %K Represent on the Stochastic Oscillator?

On a chart with a stochastic oscillator, %K is the current value of the security. It’s expressed by a percentage of the variation between its lowest and highest values for a particular time frame. Also, K is the price at present relative to the current price range.

What Does %D Represent on the Stochastic Oscillator?

In a chart of a stochastic oscillator, %D represents the three-period mean of the %K. This line can be used to display the long-term trend of prices at present and to indicate that the current trend in price is continuing for a long time time.3