Key takeaways

KDJ, also known as the stochastic indicator, is a technical indicator used to analyze short-term market trends.

KDJ reflects the intensity of price changes, as well as overbought and oversold signals.

In a volatile market, KDJ may not necessarily be effective.

Understanding KDJ

KDJ, also known as the stochastic indicator, was originally used for analysis in the futures market, and is now widely used for short-term trend analysis in the stock market. The calculation of KDJ is based on the highest price, lowest price, and closing price. It can reflect the intensity of price fluctuations, identify overbought and oversold conditions, and provide trade signals before prices rise or fall. KDJ consists of three lines in the chart.

How is KDJ calculated

KDJ is calculated by determining the relationship between the highest price, lowest price, and closing price over a specific period to obtain the Uncommitted Value (RSV), and then calculating the K value, D value, and J value using the method of smoothing moving averages, and plotting them on a chart to study price trends. The specific calculation method is as follows.

First, calculate the RSV value for a certain period, then calculate the K value, D value, and J value. KDJ can describe the short-term and medium-term market volatility characteristics by setting different time periods. Taking the calculation of daily KDJ values as an example, the calculation formula is:

n-day RSV = (Cn - Ln) / (Hn - Ln) × 100.

In this formula, Cn is the closing price on the nth day; Ln is the lowest price in the past n days; Hn is the highest price in the past n days. RSV value always fluctuates between 1 and 100.

Then calculate the K value and D value, J value, the calculation formula is:

Today's K value = 2/3 × the previous day's K value + 1/3 × today's RSV

Today's D value = 2/3 × the previous day's D value + 1/3 × today's K value

Today's J value = 3 × today's K value - 2 × today's D value

If there is no previous K value and D value, 50 can be used instead.

How to apply KDJ

Overbought and oversold

The value of KDJ ranges from 0 to 100 (sometimes J value may exceed). Generally, when D value exceeds 70, overbought signal occurs; when D value is below 30, oversold signal occurs.

Golden cross

When the K line breaks through the D line on the chart, it is commonly called a golden cross, which is a buy signal. In addition, when the K line and D line cross upwards below 20, the short-term buy signal is relatively accurate; if the K value crosses above the D value twice below 50, forming a higher golden cross resembling a "W" shape, the subsequent stock price is likely to rise, with a bullish market outlook.

Death cross

When the K value decreases and then falls below the D line from above, it is usually referred to as a death cross, considered as a sell signal. Moreover, when the K line and D line cross downwards at the 80 level, the short-term sell signal is more accurate. If the K value is above 50, crosses below the D line twice in the trend, forming a low-level death cross resembling an "M" shape, the stock price may decline subsequently.

Bottoms and tops

The J line is a directional sensitive line. When the J value continues to be greater than 90 for 5 days or more, the stock price may form a short-term peak. Conversely, when the J value is consistently less than 10 for several days, the stock price may form a short-term bottom.

Technical indicators themselves have limitations, and using technical indicators to determine market trends is very flexible. Therefore, the above parameters are for reference only. When investors use the KDJ indicator, they should combine their own risk preferences and comprehensive considerations of investment varieties.

Limitations of KDJ

The main limitation of KDJ is that it is very sensitive to price changes. In extremely volatile markets, it may generate erroneous trading signals, causing prices not to follow the signal to rise or fall, resulting in traders making incorrect judgments.