by William Blau
The stochastic oscillator devised by George Lane is one of the most useful and widely used tools in
technical analysis. This oscillator is based on the current close in relation to the highest and lowest prices
in a specified time interval (Figure 1). By definition, price increases as the close approaches the highest
price of the interval and, conversely, decreases approaching the lowest price in the interval. A maximum
is defined when price touches the highest price and then recedes. These characteristics are succinctly
expressed by Lane's stochastic:
where the oscillations are normalized within a scale of zero to 100. The subscripts (5) indicate "during"
the last five days.
The elegance of this expression is in its simplicity. The expression, however, usually suffers from
oversensitivity. Too many smaller price changes are revealed, whereas only certain peaks and valleys are
important. Ideally, smooth curves are desired to represent price where buying can be performed at or near
a price valley, with selling at or near a price peak.
An additional oscillator, %D, is used to help signal market reversals. The formula for %D is: