Stochastic is an
oscillator, that like the Relative Strength Indicator (RSI) or Contary Opinion,
can be used to indicate an overbought or oversold condition. The process has at
its root an observation that in rising markets, prices tend to accumulate near
the upper end of the day's trading range. The observation also follows for
falling markets that the close will tend to accumulate near the lower end of
the day's trading range. The result of computations described below will net
two indicators, the "%D" and "K", which are plotted
together to give a visual picture of the overbought or oversold of the data
base used.
The following paragraphs
describe two separate methods that can be used in the computation of the
stochastic. The first method uses two formulas that will compute the values for
"K" and "%D" respectively. The second method will make use
of a table (figure
1) to
arrive at the same values for "K" and "%D". Both of these
methods will compute the regular stochastic and a smoothed stochastic referred
to as the slow stochastic.
TABULAR METHOD
1) The first step in
this second method makes use of a sheet of paper that has been divided into
sixteen columns and has each column titled as shown in figure 1. Fill in columns 1, 2, 3 and 6
with the date, high, low, and close respectively.
(2) Now check back over
column 2 for the highest high during the last five day period including today
and write the value in column 4. Do the same for the lowest low during the last
five days including today and put the figure in column 5. As you write these
values in the appropriate column convert the fractional parts into eighths. Eg.
327 1/2 would be 327 4/8. The use of five day high and low is the one suggested
by one the authors, George Lane, and could be optimized for each commodity
after the process is better understood.
3) The difference
between the columns 4 and 5 should be written in column 7 and the difference
between column 4 and 6
should be written in column 8. The numbers in columns 7 and 8 should be
expressed in eighths as the following example illustrates: If the difference
were 4 6/8 then the value of the column would be 4Вґ8=32 32+6=38, so the column value for one of these two columns would be
40.
4) The difference between column 7
and 8 is written in eighths in column 9. (To check your math each day add
column 8 to column 9 which should equal the value of column 7.)
5) Total the values for the last
three days is column 7, including today, and write the result in column 11.
6) Total the values for the last
three days in column 8, including today, and write the result in column 12.
7) Total the values for the last
three days in column 9, including today, and write the result in column 13. To
check the math each day add column 13 to 12. The result should equal the value
of column 11.
8) Divide column 7 into column 9 and
place the answer in column 10. Note that the answer should be in the format of
XX.X%.
9) Divide column 11 into column 13
and place the answer in column 14. To check for math errors add column 8 to
column 9. The result should equal column 7. Likewise adding column 12 and 13
should equal column 11.
10) A smoothed value for the
stochastic can be obtained by using the last two columns. A total of the last
three days from column 14 is placed in column 15. Divide column 15 by three and
place the value in column 16. For the slow stochastic that we have just computed
column 14 is changed and now represents the value associated with "K"
while the new smoothed value for "%D" is now found in column 16.
Stochastic & RSI
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