Technical Analysis

Construction

Fast, Slow and Full Stochastic Versions:

There are three versions of Stochastic: fast, slow and full. All three indicators look at a given period and measure how today's close compares to the high-low range of the time period being considered.

Stochastics works on the principles that :

• During an uptrend, prices tend to close at the high of the candle.
• During a downtrend, prices tend to close at the low of the candle.

Stochastics attempts to show the strength of trends, and to point to times when a currency is particularly oversold or overbought.

Fast Stochastic Version

The original version, created by George C Lane, is termed the Fast Stochastic.

The simplest way to use the Stochastic indicators, other interpretations will be explained in detail later, is to look for "overbought" conditions at the indicator's 80% level, and "oversold" conditions at its 20% level. The overbought and oversold levels are displayed as dotted red lines.

The indicator plots two lines, one solid and one dotted, in its indicator panel. The two lines are called the %K line and the %D line. In the different Stochastics versions the %K and %D lines are calculated differently to add extra smoothing.

The formulas for the Fast %K and Fast %D lines are as follows:

n = number of sessions being considered in %K.

Fast %K = (Today's Close – Lowest Low in n) x 100
(Highest High in n) – Lowest Low in n)

Fast %D = 3-period moving average of %K.

The drawback to using the Fast Stochastic version is that the %K and %D lines are sensitive and they criss-cross the overbought and oversold levels often. The jaggedness of the lines creates false signals and whipsaws.

Slow Stochastic Version

Because of the Fast version's tendency to create whipsaws, traders developed the Slow Stochastic version which smoothes out the data used in the original.

• In the Slow version, technical traders smoothed the %K line by plotting its 3 period moving average. Therefore, the Slow's %K line is the same as the Fast's %D line.
• The new Slow %D line is a 3 period moving average of the Slow %K line.

The formulas for the Slow %K and Slow %D lines are as follows:

n = number of sessions being considered in %K.

Fast %K = (Today's Close – Lowest Low in n) x 100
(Highest High in n) – Lowest Low in n)

This line is not visible; it is only used to calculate the Slow %K and Slow %D.

Slow %K = 3-period moving average of Fast %K (same as Fast %D).

Slow %D = 3-period simple moving average of Slow %K (an extra layer of smoothing).

The Full Stochastic Version

Traders that did not want to be fixed with using 3-period moving averages developed the Full version. It is more versatile than the earlier two versions because it lets the user choose the periods for the Slow %K and Slow %D<.

Fast %K is the same as the Slow and Fast versions.

Full %K = N-period moving average of Fast %K (like Slow version only any N, not just 3)

Full %D = N-period simple moving average of Slow %K (like Slow version only any N, not just 3)

A Note on Periods
The number of periods one should use for the %K line depends on what purpose the trader is using the Stochastic indicator for.

• If a trader is using Stochastic in conjunction with a trend indicator to see overbought and oversold levels, one can use periods from 5 to 12.
• A period of five, when using days will look back one trading week and is popular while 12 was suggested as a good period by Lane.
  
• Most of the examples in this article will use 12 as their period.

If a trader is using Stochastic as a stand alone indicator for trading decisions or as a cycle trading indicator, periods ranging from 14 to 21 should be used.

Since the data is more spread out, the overbought and oversold levels can be adjusted from the default 20/80 levels to 30/70. 

The materials presented on this website are solely for informational purposes and are not intended as investment or trading advice. Please refer to our risk disclosure page for more information.