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Origins of the Stochastic Oscillator (Article)

The Origins Of The Stochastic Oscillator

by George A. Schade, Jr., CMT

This article answers the longstanding question who originated the %K and %D stochastic oscillator used by market technicians. The question has been debated for years. In center stage are the roles of C. Ralph Dystant (1902-1978) and George C. Lane (1921-2004).
The %K and %D stochastic oscillator is commonly associated with Lane. For many years, Lane taught its use. While he cannot be solely credited for originating the indicator, he must be recognized for his life’s work popularizing it.

I. Background

Dystant owned and operated a school called Investment Educators which opened in 1948. The Chicago based school initially offered stock market courses but in the late 1950s began offering commodities courses. In Lane’s words, Investment Educators taught “charting, moving averages, and the Elliott Wave in a series of three classes” and “was the first school to teach a heavy course in Elliott Wave.” Dystant had great interest in the Elliott Wave Principle. He wrote a book entitled “The Fifth Wave – Stocks: A Critique: The Elliott Wave.”

Lane wrote about the origins of stochastics. In an article written for the May/June 1984 issue of Technical Analysis of Stocks and Commodities (TASC), Lane stated that “in 1954,” he “was fortunate to join Investment Educators” working “for the owner, Ralph Dystant, and for the technical ‘guru’, Roy Larson.” When Mr. Larson retired, “Mr. Dystant became the guru for the stock market and [Lane] took the No. 2 spot teaching commodities.”

Lane described the origins of the %K and %D stochastic oscillator as follows:

“These were research days: 20 hour days, all calculating done by hand. The staff expanded to five. I shall not mention names, as they are all well-off financially, still trading, and don’t wish to be bothered.

In our research, our indicators were running all over the page, so we developed the technique of expressing them as a percentage of 100.

We developed %A, found it didn’t work. We went on to research and to follow 28 oscillators. As we progressed through the oscillators we were developing, we expressed them as percentages as well; thus: %D, %K, %R.….

In the sixties, we pioneered using the computer to test our oscillators.”

In May 1985, the CMT Association Journal (now the Journal of Technical Analysis) published an article written by Lane, in which he explained that:

“In 1954, I joined Investment Educators as a junior analyst….

After I joined the six-man, no-pay research staff, we discovered oscillators. We researched and experimented with over sixty applications, with the result that we found about twenty-eight that had predictable values. In charting our cumulative oscillators, we found they were running all over the chart paper. Soon, we had chart paper running all over the walls. So, we struck upon the technique of reducing these oscillators to a percentage. We used the alphabet to differentiate one from the other: %A, %B, etc. Each one was reduced to a percentage indicator primarily so we could manage to keep them workable on the chart paper!

As a result of all the hard work (the 14-hour, mostly by hand, no-pay days), we decided that the most reliable indicator was %D for ‘% of Deviation.’ The basic premise of %D is that momentum leads price.”

Although Lane wrote that others – expressed in the collective “we” – had been involved in the invention of the stochastic oscillator, he made contradictory assertions. The 1984 TASC article was entitled Lane’s Stochastics. The 1985 CMT Association Journal article was entitled Lane’s Stochastics: The Ultimate Oscillator, called the indicator “Lane’s Stochastics,” and contained one chart depicting “Lane’s Stochastics.”

An 80-page pamphlet with appendix and glossary “Written by George C. Lane” and copyrighted in 1986 by Caire Abrams Lane (Lane’s wife and widow), was entitled Using STOCHASTICS, Cycles & …to the Moment of Decision…. It profiled Lane as the “Originator of Stochastics.” Throughout the pamphlet and in several of its charts, the indicator was called “Lane’s Stochastics.”

In the handout to a 1999 presentation, Lane stated he was “known as ‘The Father of Stochastics.’” The current website of the entity offering seminars on using stochastics, www.lanestochastics.com, states that Lane “originated” stochastics.

By 1999, the history of the oscillator had received attention. In 1986, in the first edition of his book Technical Analysis of the Futures Markets, noted analyst John J. Murphy wrote that “The Stochastic Process was invented by George Lane…” The updated and expanded edition published in 1999 modified this sentence to read “The Stochastic oscillator was popularized by George Lane…”

II. The STOCHASTIC PROCESS Document

Both the 1984 TASC article and the appendix to the 1986 Using STOCHASTICS, Cycles & …to the Moment of Decision… pamphlet share a remarkable element. The article and appendix are essentially the same, but more striking is that this material has been claimed to have been published as part of the Elliott Wave Principle course that Investment Educators sold in the 1960s. As will be seen, in this history, this document is seminal.

Market historian Gibbons Burke (1992) has written that the stochastic “indicator was originally introduced by Investment Educators as part of an Elliott wave course.” In 1995, Lane wrote in a presentation handout that “our 1950’s work….was written as a quick reference guide for students who had taken Elliott Wave and Stochastic courses from us…”

I have a copy of an 8-page document claimed to have been part of the course. Pages 1 through 6 are repeated almost verbatim in both the 1984 TASC article and 1986 appendix. Across the top of the other two pages is the title “Elliott Wave Principle.”

On page 1, the document is entitled STOCHASTIC PROCESS. Burke wrote that this document was the source of the name given to the %K and %D oscillator:

“According to Tim Slater, founder and president of CompuTrac, Inc., the name ‘stochastic’ is a misnomer attached to the %D indicator by mistake. When Slater implemented the indicator into CompuTrac, he needed a name for it other than the cryptic %K and %D. The words ‘stochastic process’ happened to have been handwritten on the original Investment Educators literature provided to him so he used that. The name remains.”

I spoke with Mr. Slater who confirmed this account. Two conclusions flow from the document.

First, the fact that Lane repeated the contents of that document in 1984 and 1986 publications and later partially in handouts for the 1995 and 1999 CompuTrac conferences shows he recognized that document as being the original source description of the %K and %D stochastic oscillator.

The second conclusion is that the document entitled STOCHASTIC PROCESS was first published in 1957, making that the year of the first articulation of the %K and %D oscillator. The 1986 pamphlet stated that the STOCHASTIC PROCESS document was copyrighted in 1957:

“How to Use Lane’s Stochastic originally published as The Stochastic Process © 1957 by George C. Lane, used by permission of author. Other portions of appendix © 1957 and 1982 by George C. Lane, used by permission of author.”

The reference to 1982 is likely related to the glossary in the pamphlet. The pamphlet had both an appendix (The Mechanics of Stochastics) and a glossary. The appendix reiterated the STOCHASTIC PROCESS document.

Analyst Nina G. Cooper (2004) wrote that stochastics “have been around since 1957,” further adding weight to this conclusion. Market wizard Jack Schwager (1996) wrote that the “stochastic oscillator was developed … in the late 1950s.”

I corresponded with Mrs. Caire Abrams Lane, Lane’s widow. According to her, Lane wrote the original materials explaining the rules for the methodology. This assertion explains why Lane claimed the 1957 copyright.

Because this document was part of a course sold by Investment Educators, some have inferred that Dystant invented the stochastic oscillator. The inference is not plausible because it overlooks the fact that someone else, even one associated with the school, could have originated the indicator and written the guidelines.

A. The Collegial Traders

Audio tapes and the handouts of Lane’s presentations in 1995 (TAG 17 Conference) and 1999 (TAG 21 Conference) shed light on the collaborative effort of a group of traders who created the %K and %D stochastic oscillator.

At TAG 17, Lane stated that he “and a bunch of others…were trying to find something to help us make a decision.” They found that the %K and %D stochastics were the best to determine momentum. “We didn’t know what we had, but it worked.” The group traded during the day and researched after the close.

At TAG 21, Lane related “there were seven of us” trading commodities at the Chicago Board of Trade. After the trading day ended, they returned to Investment Educators where “we looked for something, something to help us make decisions, when to buy and when to sell.” One evening, a member of the group, who was from Czechoslovakia, introduced his grandfather to the group. The grandfather suggested trying a formula he knew was used to determine how much limestone to add to a mixture to make steel. In Lane’s words, “so we took it, and massaged it, and changed it and that’s stochastics.” The claim made by some that a Czechoslovakian invented stochastics is incorrect. In his presentation, Lane spoke of “when we invented” and “we discovered” the stochastic oscillator.

The TAG 21 handout stated, “Early in his career, George spearheaded a research group that originated a number of technical indicators, most notably the Stochastic Process (Lane’s Stochastics).” The extent of Lane’s leadership is unclear, but it is clear that the group “originated” the oscillator to which Lane gave his name.

In his 1984 article, Lane commented, “One of the thrills of my life has been to find out that another of our members has been testing %D with an econometric indicator developed at [the] University of Michigan (where we perfected %D) and has found it to be predictive.” At TAG 21, Lane shed light on the connection between %D and Michigan. He described how “one of our friends” was surreptitiously “at night” using the “super computers” at the University of Michigan to test and back test formulas and data – “that’s how we researched” stochastics. When discovered, the friend was asked to leave, and he returned to Chicago with “all our research papers.”

Lane’s TAG 21 handout described the oscillator’s origin as a group effort (note the collective “we”):

“We…developed an oscillator that would show this tendency through the use of a ratio.

We optimized it, smoothing it twice. Then, we converted it to a (%) percentage oscillator.” (Underlining in handout.)

According to Mrs. Lane, Dystant did not participate in or support the group. However, Dystant became interested in what the group of traders had developed, and Lane taught the method while affiliated with Dystant.

B. The Slow Stochastic Oscillator

Lane taught %K and %D (called Fast Stochastic). The formulas are shown in the sidebar. Slow stochastic drops the %K line and makes the %D line the new %K line. The %D line is smoothed with a three-period moving average. Lane did not claim he invented the slow stochastic. His TAG 17 handout stated, “TAG developed Slow Stochastics and Tim Slater changed the name from The Stochastic Process to ‘Stochastics,’ which has stuck.” In that 1995 presentation, Lane related that a “crew” at CompuTrac had come up with the slow stochastic oscillator.

CompuTrac did not create the slow stochastic oscillator. According to Slater, CompuTrac programmed, but did not originate, the slow stochastic. CompuTrac added the slow stochastic oscillator to its database in 1978. It has been posited by others that Dystant developed the slow stochastic. Nonetheless, Lane did not claim he originated the slow stochastic oscillator.

III. Conclusions

This research leads to five conclusions:

  1. George C. Lane was not the sole originator of the %K and %D stochastic oscillator.
  2. The collaborative effort of several individuals who were futures traders, including Lane, led to the creation of the %K and %D stochastic oscillator. The others remain nameless. Reportedly, Dystant was not a member of the group.
  3. The methodology of the %K and %D stochastic oscillator was first described in 1957.
  4. Lane contributed significantly to the acceptance and popularity of the stochastic oscillator as a technical indicator.
  5. The slow stochastic oscillator came later and was publicized after 1978. Lane did not claim he originated the slow stochastic oscillator.

While many terms in technical analysis are imprecisely defined, the terms fast and slow stochastic oscillators are well understood:

The stochastic oscillator compares where a security’s price closed relative to its range over a given period. It is plotted as two lines: %K and %D.

The formulas for the %K and %D oscillator – Fast Stochastic – are:

%K = 100*[(C – Ln) / (Hn – Ln)]

where C is the current closing price and H and L are the highest and lowest closing prices over the last n periods, and

%D = 100*(H3/L3)

where H3 is the three-day sum of (C – Ln), and L3 is the three-day sum of (Hn – Ln).

In Slow Stochastic, the %K line is replaced with the %D line. A three-day moving average of %D becomes the slow stochastic %D line

References

  • Achelis, Steven B., 1995, Technical Analysis From A to Z (McGraw-Hill, New York, NY), p. 268.
  • Burke, Gibbons, 1992, Taking A New Look at the Stochastic ‘Family,’ Futures (March), pp. 36-38.
  • Cooper, Nina G., 2004, Spotlight on Facts and Myths of Misunderstood StochasticsSFO: Stocks, Futures and Options (Nov.).
  • DeMark, Thomas R., 1997, New Market Timing Techniques: Innovative Studies in Market Rhythm & Price Exhaustion (John Wiley & Sons, Hoboken, NJ), p. 2.
  • Lane, George C., 1984, Lane’s StochasticsTechnical Analysis of Stocks & Commodities, vol. 2, ch. 3 (May/June), pp. 87-90.
  • Lane, George C., 1984, Stochastics, A CompilationofTechnical Tools and Guidelines Used By Futures Professionals (Futures Symposium International Speakers, Tucson, AZ).
  • Lane, George C., 1985, Lane’s Stochastics: The Ultimate OscillatorCMT Association Journal (now the Journal of Technical Analysis), issue 21 (May), pp. 37-42.
  • Lane, George C.,1986, Using STOCHASTICS, Cycles & …to the Moment of Decision… (Investment Educators, Watseka, IL).
  • Lane, George C., 1995, Audio Tape and Handout, TAG 17 Conference, Las Vegas, NV, available at http://tv.ino.com/premium/faq.html.
  • Lane, George C., 1999, Audio Tape and Handout, TAG 21 Conference, Las Vegas, NV, available at http://tv.ino.com/premium/faq.html.
  • Murphy, John J., 1986, Technical Analysis of the Futures Markets: A Comprehensive Guide to Trading Methods and Applications (New York Institute of Finance, New York, NY), p. 304.
  • Murphy, John J., 1999, Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications (New York Institute of Finance, New York, NY), p. 246. This is an updated and expanded edition of the 1986 book.
  • Schwager, Jack D., 1996, Schwager on Futures: Technical Analysis (John Wiley & Sons, Hoboken, NJ), p. 545.

George A. Schade, Jr., CMT, is an accomplished market historian. The author thanks Gregory L. Morris for editorial suggestions.