KST Oscillator – Strategy, Rules, Returns
As traders, we rely on different technical analysis tools to gain valuable insights into market movements and attempt to predict the future price direction — the KST oscillator is one tool that is worth checking out. What do you know about this indicator?
A short form for Know Sure Thing, the KST oscillator is a complex momentum indicator that is based on the smoothed rate-of-change for four different periods. Basically, the KST is a weighted average of four different rate-of-change values that have been smoothed. Martin Pring created it to make the rate of change indicator easy to apply in trading, offering overbought/oversold signals, signal line and centerline crossovers, and divergence signals.
In this post, we will take a look at most of the questions you may have about this indicator: what it is, how it works, and how you can improve your trading strategies with it. Let’s dive in!
Key takeaways
- The KST oscillator is a complex momentum indicator that is based on the smoothed rate-of-change for four different periods.
- Martin Pring created the indicator.
- We show you a backtested KST Oscillator trading strategy complete with trading rules and settings.
- For a full list of all trading indicators, please click on the link.
What is the KST Oscillator?
A short form for Know Sure Thing, the KST oscillator is a complex momentum indicator that is based on the smoothed rate-of-change for four different periods. Basically, the KST is a weighted average of four different rate-of-change values that have been smoothed. Martin Pring created it to make the rate of change indicator easy to apply in trading, offering overbought/oversold signals, signal line and centerline crossovers, and divergence signals.
The oscillator tracks the momentum of four different rate-of-change indicators of varying periods and combines them into a single momentum oscillator. It oscillates around the zero centerline and generates a signal when the indicator reaches the overbought/oversold levels and crosses over the signal line. Traders also use the centerline crossover to gauge price momentum and the indicator’s divergence from price action to anticipate a price reversal. However, the best approach is to combine the indicator with other analysis tools to create a reliable strategy.
KST Oscillator trading strategy – trading rules, settings, backtest, returns, and performance
Let’s put the indicator to the test. The only way to determine if the indicator has any predictive power is to make quantified trading rules and backtest it.
We make the following trading rules:
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If we apply the above settings, we get the following returns for the gold price (GLD, daily bars, from inception until today):
Trading performance metrics and statistics from GLD’s inception until today:
- Number of trades: 200
- Average gain per trade: 0.7%
- Annual returns: 6.6%
- Win rate: 43%
- Time spent in the market: 50%
- Risk-adjusted return: 13.1%
- Max drawdown: 24%
We backtested the trading rules on stock indices and single stocks, but the performance was poor.
The code of the strategy reads like this (Amibroker)
THIS SECTION IS FOR MEMBERS ONLY. _________________ BECOME A MEBER TO GET ACCESS TO TRADING RULES IN ALL ARTICLES
CLICK HERE TO SEE ALL 350 ARTICLES WITH TRADING RULES
How does the KST Oscillator work?
The KST works by weighting the values of different rate-of-change indicators of varying periods and combining them into a single momentum oscillator that helps traders identify the strength of price movements and anticipate potential reversals. It generates overbought and oversold signals, signal line and centerline crossovers, and divergence signals.
When the oscillator crosses above the zero line (centerline), the market is presumed to have a positive momentum in the upward direction. But when it reaches an extreme level above the centerline, the market is presumed overbought and could soon reverse.
At this extreme positive level, if the indicator crosses the signal line and starts declining, a price reversal is expected, at least in the short term. When the indicator falls below the centerline, the price is presumed to be gaining momentum on the downside. If the indicator gets to extreme negative levels, the market is said to be oversold, and when the indicator crosses the signal line and climbs up, the downswing is expected to reverse.
Who created the KST Oscillator?
The KST oscillator was created by Martin Pring. He created the indicator to make it easy for traders to interpret the price rate of change (ROC) indicator and be able to apply it in their trading effectively.
He figured that the way to achieve that objective is to attach weights to different period ROCs and combine them into one indicator, which he called “Know Sure Thing” or KST. He took the simple moving average (SMA) of four different ROC periods and added them together to get the KST, then got a 9-period SMA of the KST as the signal line.
Why use the KST Oscillator?
Traders use the KST oscillator because it helps them gauge the momentum of market trends and anticipate potential reversals. When the indicator rises from an oversold level and crosses above the signal line, it signifies a rising momentum to the upside and a potential upside trend is emerging. The momentum becomes even stronger when the indicator crosses above the centerline.
On the other hand, when the indicator is falling from an overbought level and crosses below the signal line, it signifies a rising downside momentum and a potentially emerging downside trend. The momentum becomes even stronger when the indicator crosses below the centerline. Traders also use the oscillator to identify divergences, which signal potential price reversals.
When was the KST Oscillator developed?
The KST oscillator was created in 1992 by Martin Pring. The founder first introduced the indicator in the 1992 edition of Stocks & Commodities magazine in an article titled: “Summed Rate of Change (KST)”.
Pring created the indicator to make it easy for traders to interpret the price rate of change (ROC) indicator so they can effectively apply it in their trading. Since then, the indicator has gradually grown in popularity, and it is now built into many trading platforms.
What does KST stand for?
KST stands for “Know Sure Thing.” It is a momentum indicator developed by Martin Pring in 1992 to help traders make better use of the price rate of change in their trading analysis. The indicator combines four smoothened ROC indicators of different weights to get a single oscillator that shows price momentum and potential reversals.
Traders use the overbought and oversold signals to gauge overextended price action and use the centerline crossover to know where the momentum lies. Divergences from price action are seen as a potential reversal signal.
How is the KST Oscillator calculated?
The KST oscillator is calculated as follows:
Step 1: Calculate the ROC in 4 different periods
ROC = [(Current price/ Closing price n-periods away) -1] x 100
Where the default values for n are as follows:
ROC1: n = 10 periods
ROC2: n = 15 periods
ROC3: n = 20 periods
ROC4: n = 30 periods
Step 2: Calculate the moving averages of the various ROCs
ROCMA1 = 10-Period SMA of 10-Period ROC
ROCMA2 = 10-Period SMA of 15-Period ROC
ROCMA3 = 10-Period SMA of 20-Period ROC
ROCMA4 = 15-Period SMA of 30-Period ROC
Step 3: Calculate the KST
KST = (ROCMA1 x 1) + (ROCMA2 x 2) + (ROCMA3 x 3) + (ROCMA4 x 4)
Step 4: Calculate the Signal Line
Signal Line = 9-period SMA of KST
What are the components of the KST Oscillator?
The components of the KST oscillator are the ROCs, the moving average of the ROCs, the KST line, and the Signal Line.
- The ROCs: There are four rate of change indicators with different periods — 10-period ROC, 15-period ROC, 20-period ROC, and 30-period ROC.
- The ROCMAs: They are the moving average of the ROCs. The default is a 10-period moving average for the first three ROCs and a 15-period moving average for the fourth ROC.
- KST Line: The KST line is calculated by summing the moving average of four different ROCs while applying the appropriate weight for each.
- The Signal Line: This is a 9-period simple moving average of the KST line.
How to interpret KST Oscillator signals?
To interpret KST oscillator signals, you have to understand how the indicator works and the type of signals it generates. The indicator generates four types of signals: centerline crossovers, overbought/oversold signals, divergences, and signal line crossovers.
When the oscillator crosses above the zero line (centerline), the market is presumed to have a positive momentum in the upward direction. Conversely, when the indicator falls below the centerline, the price is presumed to be gaining momentum on the downside.
If the indicator reaches an extreme level above the centerline, the market is presumed overbought and could soon reverse. When the indicator gets to extreme negative levels, the market is said to be oversold and could reverse to the upside.
At the extreme positive level, if the indicator crosses the signal line and starts declining, an opposite trend is emerging, at least in the short term. At the extreme negative level, when the indicator crosses the signal line and climbs up, a new short-term uptrend is expected. A divergence from the price is interpreted as a sign of price reversal.
What is a KST buy signal?
A typical KST buy signal is the indicator rising from an extreme negative level and crossing above the signal line. For this to be a reliable buy signal, the price must be in an uptrend.
So, the KST buy signal tells you when a pullback in a trending market is about to reverse for the trend to continue. When the indicator is oversold and then, it starts climbing up again, crossing above the signal line, it means the market is rising again after a pullback.
What is a KST sell signal?
A typical KST sell signal is the indicator falling from an extreme positive level and crossing below the signal line. For this to be a reliable sell signal, the price must be in a downtrend. So, the KST sell signal tells you when a pullback in the down-trending market is about to reverse for the trend to continue. When the indicator is overbought and then, starts declining, crossing below the signal line, it means the market has started falling again after a rally (pullback).
How to use KST in trading?
To use The KST in trading, you have to combine it with other indicators to formulate a reliable trading strategy with clear entry and exit criteria. You may combine it with indicators that show the main price trend so you can use the KST to know when the market is oversold in an uptrend and overbought in a downtrend. Divergences and signal line crossovers can also help you identify when a pullback is potentially over so you trade in the trend direction.
What are the KST Oscillator settings?
The KST oscillator settings will depend on what you want, but the default settings are as follows: KST(10,15,20,30,10,10,10,15,9). The first four numbers are the settings for the periods of the four ROCs, while the next four are the settings for the moving average periods for ROCs.
The last number is the period of signal line moving average. However, you can change the settings to what works best for your strategy and the market you’re trading.
How to optimize KST Oscillator settings?
To optimize the KST oscillator settings, you have to use the indicator to formulate a trading strategy with clear entry and exit criteria and, then, backtest the strategy with different settings of the indicator to see the ones that work best for the markets you are trading and the various market conditions.
Then, you play around with various settings using out-of-sample data to get the best performance for the strategy for the chosen settings or you forward-test the strategy.
What are KST Oscillator divergences?
KST oscillator divergences refer to situations when the indicator movement is out of phase with the price swings — the price could be making a higher high, while the indicator is making a lower high. Divergences are of different types.
They can be bullish or bearish. When the indicator is making a higher low while the price is making a lower low, it is called a bullish divergence. On the other hand, when the indicator is making a lower high while the price is making a higher high, it is called a bearish divergence.
How does KST compare to MACD?
The KST compares to the MACD in that they both have indicator lines and signal lines and oscillate around the zero centerline. Also, signal line crossovers are important signals in both indicators, with the indicator crossing above or below the signal line indicating a shift in price momentum.
However, the indicators differ in how they are calculated — the KST combines four weighted ROC moving averages of various ROC and moving average periods, while the MACD finds the difference between a 13-period EMA and a 26-period EMA.
Can KST be used with other indicators?
Yes, the KST can be used with other indicators to create more reliable strategies and improve the accuracy of its signals. It is best to combine the KST with indicators that show the direction of the main trend and those that show very short-term overbought/oversold conditions, as the KST itself is more in tune with the short-to-medium-term price momentum.
You can also combine it with other analysis tools, such as trendlines, support/resistance levels, and candlestick patterns.
What are the advantages of the KST Oscillator?
The advantages of the KST oscillator include:
- It can help you gauge the short-term or medium-term price momentum
- It can be used to generate buy and sell signals when combined with trend indicators
- It can tell potential price reversals via divergence signals
What are the limitations of the KST Oscillator?
The limitations of the KST oscillators include:
- Unreliable signals: The KST oscillator can produce too many false signals when used alone, especially in sideways or range-bound markets.
- Lagging: The KST is calculated from historical data and, as such, is liable to lag behind real-time price action, leading to late entries and exits.
- Not a standalone strategy: The indicator cannot be used alone as a trading strategy — it must be combined with other analysis tools to get the best out of it.
How to backtest the KST Oscillator?
To backtest the KST oscillator, you have to follow these steps:
- Study the indicator to understand how it works so you know the right tools to combine with it to formulate a trading strategy
- Identify the markets you want to test the strategy on
- Create a trading strategy with clear entry and exit points
- Formulate your risk management parameters
- Code the strategy and risk management rules into a trading algorithm
- Determine the length of data for your backtesting and separate your in-sample and out-of-sample data
- Run your backtesting on the in-sample data and use the out-of-sample data to optimize your strategy
- Analyze the results of the backtesting
Can the KST Oscillator predict market trends?
Yes, the KST oscillator can predict market trends, but as with any other indicator, it cannot accurately do that all the time. Sometimes, the KST will indicate a market trend and it will happen as predicted. But other times, it goes off the mark, as the market conditions can change at any time.
Moreover, the indicator only uses past price data, which cannot foresee what will happen in the future.
Is the KST Oscillator suitable for beginners?
Yes, the KST oscillator is suitable for beginners if they understand how the indicator works and know how to combine it with other indicators to formulate reliable trading strategies.
As a beginner, what you need to do is have a strategy that shows you when to buy and when to close your position or when to go short and when to cover your position. You can achieve that with the KST oscillator. But you must backtest the strategy before you put money on the line.
How to avoid KST Oscillator false signals?
To avoid KST oscillator false signals, you have to combine the indicator with other indicators or analysis tools. For instance, if you combine it with long-term trend indicators, you can identify the main trend and use the KST to find trading opportunities in the direction of the trend.
If the market is trending up, you avoid sell signals from the KST and focus only on buy signals. This way, you don’t trade against the trend and, thus, reduce the chances of false signals.
What are common mistakes with the KST Oscillator?
The common mistakes with the KST oscillator include:
- Not combining the indicator with other analysis tools to improve its signals
- Using it as a standalone trading strategy
- Trading against the direction of the main trend
- Not having a risk management plan
Where to find KST Oscillator resources?
These are some of the places where to find KST oscillator resources:
Books: You can find a lot in Martin Pring’s book: “Technical Analysis Explained”. Another good book that offers great insights into the KST indicator is “Momentum, Direction, and Divergence” by William Blau.
Trading Blogs and Online Courses: You can learn a lot from trading blogs like the one you’re reading now, as well as other websites like therobustrader.com and quantifiedstrategies.com. You can also enroll in online courses to learn more
Forums and Communities: You can discuss with fellow traders on trading forums and communities to gain ideas, share experiences, and learn about the KST indicator.
Trading Platforms and Backtesting Software: You can practice with the indicator on your trading platform until you understand how to use it. Also, use the backtesting software to test the settings of the KST indicator to know what works best for you.