# Stochastics: Oscillator Measures the Power of a Price Move

The stochastic oscillator is a momentum indicator that measures how powerful a price move is. Although the formula can be applied to any kind of data, it is most often used with closing prices of stocks, ETFs or other tradable securities. The indicator shows where the closing price is in relation to the recent trading activity.

The stochastics formula is: (Current Close – Lowest Low) / (Highest High – Lowest Low) * 100

The lowest low and highest high are measured over a look-back period, typically 14 days. These values can change each day. The ratio is multiplied by 100 so the stochastics is always expressed as a percentage.

When the close is near the recent lowest low, the stochastic oscillator will be near 0 and the price may be considered oversold. An overbought condition exists when the current close is near the highest high and the stochastic value is near 100.

Trading solely with the stochastic oscillator is challenging. Trade signals are generated when the indicator moves above or below key levels.

In the example shown below, using the blue line in the middle of the chart, buy signals are given when the indicator moves above 20 and sell signals occur when it falls below 80. One problem with this approach is that there can be repeated buy signals before a sell signal occurs, or vice versa. It is also possible that a new trend could develop without a signal being given. To address these problems, some traders add a moving average to the stochastic indicator. The indicator itself can be slowed with a moving average, creating what is called a slow stochastic. The raw indicator values are called the fast stochastic. Then a moving average is placed on top of the slow stochastic. A common moving average is three days for both calculations.

This technique, applied as a three-day moving average on the slow stochastic, is shown in the bottom portion of the chart above. Signals are more frequent and can now occur at any time, rather than only at oversold or overbought extremes.