KDJ, the stochastic oscillator was developed in the late 1950s by George Lane. As designed by Lane, the stochastic oscillator presents the location of the closing price of a stock in relation to the high and low range of the price of a stock over a period of time, typically a 14-day period. Lane, over the course of numerous interviews, has said that the stochastic oscillator does not follow price or volume or anything similar. He indicates that the oscillator follows the speed or momentum of price. Lane also reveals in interviews that, as a rule, the momentum or speed of the price of
a stock changes before the price changes itself.
In this way, the stochastic oscillator can be used to foreshadow reversals when the indicator reveals bullish or bearish divergences. This signal is the first, and arguably the most important, trading signal Lane identified.
For those of you who don’t know
stochastic it is an oscillator. The formula compares the current close to the low, high and range of a set period and then creates two lines, %K and %D. %K is the faster line, %D is simply a moving average of %K and provides a signal line.
The KDJ adds a third line, the %J, for a total of three; The %J line is nothing more than the difference between the other two lines, very similar to MACD. The big difference between %J and MACD is one, it isn’t presented as a histogram and two, the two figures are weighted giving more emphasis on the shorter term.
This creates a line that moves very slowly and has the ability to move outside the range of the typical stochastic indicator. Stochastic ranges between 0 and 100, KDJ can move outside this range and that movement is one of the signals it can give.
It works a lot like regular stochastic. The most common signals it gives are based on where %J is in the range.
If it is between 20 and 80 the market is neutral, if it is above 80 it is bullish or overbought and if it is below 20 it is bearish or oversold. investors have to be really careful at this stage.
Buy signal when J goes under 0 when K and J are in oversold area. Sell signal when J goes above 100 when K and J are in
overbought area. These lines are used for crossovers in either direction but best used in line with the trend.
More advanced signals include divergence and convergence with
trend that can foreshadow underlying strength or weakness. Don’t forget about the original %K and %D because they help to weed out a lot of the false signals. When they confirm %J， the trade has a much better chance of moving into the money.