The Slow Stochastic is an oscillator type indicator that is used to help identify changes in momentum while identifying support and resistance levels. Its basic function is to identify that during periods of price decreases, daily closes tend to accumulate near the lows of the trading range. Conversely, during periods of price increases, closing prices tend to accumulate near the highs of the range. The purpose of using this indicator is to identify markets that are in overbought or oversold territories and trending for a reversal.
The Slow Stochastic Indicator is plotted on a chart using a range of 0 to 100. When the Stochastic lines are above 80 it is considered overbought, and when they are below 20 it is considered oversold. For more conservative traders, you can use the 75 and 25 levels respectively. For the most reliable read, look for the divergence level (%D) to be between 10-15 for a BUY signal and between 85-90 for a SELL signal.
Sideways or range bound markets are not the optimum conditions with which to use this indicator. The Slow Stochastic Indicator is best utilized in a trending market.
The Stochastic Indicator is comprised of two parts:
- The %K indicator line (generally denoted in red) is the number of periods used in the calculation of the study. It is the faster moving line. N period default is generally set to 14.
%K = (Today’s closing price) – (lowest price of the last N period)
(Highest high during the last N period) – (lowest low of the last N period)
- The %D indicator line (generally denoted in blue) is the number of periods used to calculate the moving average. It is the slower moving line. N period default is generally set to three.
%D= The Moving Average of the %K stochastic indicator
We use the Slow Stochastic as an indication of a trend change and as an alert to bring our attention to a certain market set-up and a possible trade. While it generally is an early indication, we remain aware of false reads that may be given, and we believe it is of the utmost importance that this indicator be used in conjunction with other indicators, such as the MACD (moving average convergence divergence) and Moving Averages.
It is important to remember that technical indicators do not guarantee what is going to happen, so they should be used as a guide to prepare you for what is likely to happen. By blending these three indicators we are able to identify high quality entry and exit points.
When using this indicator you will want to pay attention to what the %K line is doing in comparison to the %D line.
See the chart at the end of this article for an example of how it looks and works
We look for a Bullish reversal signal when both lines approach the 20 level:
- BUY signals are generated when the %K line crosses over the %D line to the UPSIDE
We look for a Bearish reversal signal when both lines approach the 80 level:
- SELL signals are generated when the %K line crosses over the %D line to the DOWNSIDE
When one of these patterns appears, you should anticipate a market signal.