The Stochastic Oscillator was popularized by George Lane (president of Investment Educators, Inc., Watseka, IL). It is based on the observation that as prices increase, closing prices tend to be closer to the upper end of the price range. In downtrends the closing price tends to be near the lower end of the range.
The Stochastic Oscillator is made up of two lines that oscillate between a vertical scale of 0 to 100. The %K is the main line and it is drawn as a solid line. The second is the %D line and is a moving average of %K. The %D line is drawn as a dotted line.
The Fast Stochastic is the average of the last three %K and a Slow Stochastic is a three day average of the Fast Stochastic. Use as a buy/sell signal generator, buying when fast moves above slow and selling when fast moves below slow. Most traders use the Slow Stochastics because of its more reliable signals.
Three ways to interpret the Stochastic Oscillator:
Buy when the Oscillator (either %K or %D) falls below 20 and then rises back above that level. Sell when the Oscillator rises above 80 and then falls below that level.
Buy when the %K line rises above the %D line and sell when the %K line falls below the %D line.
Look for divergences - prices making a series of new highs as the Stochastic Oscillator is failing to surpass its previous highs.