Just like William %R, Stochastic %K and %D indicates the momentum of a stock. It uses the current close price of the stock and it’s high – low range to understand whether a stock is in overbought / oversold range. The indicator is based on the assumption that in an upward trending market, prices will close near the day’s high and in downward trending market, prices will close near the day’s low.
Stochastic %K is calculated using the formula:
(Current Close – Lowest Low)/(Highest High – Lowest Low) * 100
It uses a 14 day lookback period. Stochastic %D is the 3 days simple moving average of %K. The %D number acts as a signal or trigger point.
Both %K and %D values range between 0 and 100. Buying and selling signals are generated when %K and %D come close to each other. When %K point moves above %D point, buy signal is generated. A sell signal is generated when %K crosses below %D.
Values of %D line that are above 80 indicates that the security is overbought and values below 20 indicates that it is oversold.