Double Stochastics

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The Double Stochastic Oscillator is an advanced version of the Stochastic Oscillator that was developed by George C. Lane in the 1950s. The stochastic oscillator is considered to be one of the most widely used tools in technical analysis. The Stochastics Oscillator is based on the current close price in relation to the highest and lowest prices during an analyzed time interval. The Double Stochastics Oscillator uses the same principle (formula) as the Stochastics Oscillator with the only difference being that for the Stochastics Oscillator the formula is applied to the price and for the Double Stochastics Oscillator the same formula is applied to the Stochastics.

Like the Stochastics Oscillator, the Double Stochastics Oscillator is plotted on a chart as two lines, %K and %D, where %K is the fast (main) line and %D is a slow line that is used as the signal line. The Stochastics formula is:

Stochastics(n) = 100 * (Recent Close - Lowest Low) / (Highest High - Lowest Low);

Respectfully the Double Stochastics is calculated as

Double Stochastics(n) = 100 * (Recent Stochastics - Lowest Stochastics) / (Highest Stochastics - Lowest Stochastics);

where n is the number of bars (period) used to define the lowest and highest Price or Stochastics values.

From the S&P 500 chart below you can see that Stochastics and Double Stochastics lines move in the same pattern most of the time. However, the Double Stochastics moves more dynamically by spending less time in the middle area (between 20% and 80%).

Chart 1:S&P 500 Index (^SPX) - Stochastics and Double Stochastics

The Double Stochastic Oscillator can be analyzed in the same way as other Stochastic Oscillators. It oscillates between 0 and 100% and was developed to locate the recent close in relation to the high/low range. As in the case of the original Stochastic Oscillators, technical analysis states that, in rising markets (bullish markets), Double Stochastics moves close to 100% (above 80%) and in declining markets (bearish markets), the Double Stochastics tends to move closer to 0% (below 20%).

There are three basic ways to generate trading signals based on the technical analysis of the Double Stochastic Oscillator:

1. Crossovers of fast (%K) and slow (%D) lines: A "Buy" signal is generated when fast Stochastics moves above slow Stochastics and a "Sell" signal occurs when the fast line drops below the slow line.
2.  Crossovers of fast (%K) line with 50%: A "Buy" signal is generated when the fast Stochastic line crosses above 50% and a "Sell" signal is given when it crosses below 50%.
3.  Crossovers of fast (%K) line with oversold/overbought levels: In technical analysis a stock (analyzed security) is considered overbought when Stochastics moves above 80%. Alternatively, a stock is considered oversold when Stochastics drops below 20%. Furthermore, a "Buy" signal could be generated when Stochastics moves above 20% after being below this level and a "Sell" signal is generated when Stochastics moves below 80% after being above that level.
4.  Divergence between price and Stochastics: A divergence is considered bullish when the price reaches new lows, but Stochastics achieves higher lows. A "Buy" decision could be made at this point. The times when the price reaches a new high, but the Double Stochastics does not achieve a new high are considered as Bearish divergence and could be considered as "Sell" signals.

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