KDJ indicator is used to analyze and predict price changes in tradable assets. The KDJ technical indicator is also known as the random index since it is mostly used for short-term periods and in market trend analysis.
KDJ is a derived form of the Stochastic Oscillator Indicator. Just like Stochastic Oscillator KDJ has the K and D lines but it differs because it is adding an extra line called the J line. If you have used the Stochastic indicator before you know that it cannot be used in flat markets, the same goes for KDJ.
The formula for the Stochastic Oscillator looks like this:
C – The most recent closing price.
L14 – The lowest price traded of the 14 previous trading periods
H14 – The highest price traded during the same 14 periods
%K – The current value of the stochastic indicator
The number 14 in the formula represents 14 periods. Depending on the objectives of the technical analysis, this period can be daily, weekly, monthly.
KDJ is calculated quite alike a Stochastic indicator, but the difference is in having a J line, which Stochastic does not have.
The %K is referred to as the fast-stochastic indicator whereas the slow stochastic indicator is taken as %D = 3 period moving average of %K.
The theory suggests that the indicator acts according to the market trends also mentioned above. For example, when the market is trending upwards, prices will close near the high. On the other hand, when the market is trending downward, the price closes near the low.
The signals are triggered when the %K crosses through the 3-period moving average, called the %D. Values of %K show if the security is overbought, therefore above 80, or oversold, below 20.
The moments of %K crossing %D are the moments for selling or buying. The J line represents the divergence of the %D value from the %K. The value of J can go beyond the range of 0-100 for %K and %D lines on the chart. Overall, the stochastic oscillator is always ranging between 0-100.
When it comes to determining the trend, as well as when to enter a trade, the KDJ indicator is your friend. If the lines are all in the overbought zone, with the J-line (especially) being above the other two, then it’s usually a good idea to SELL. The opposite is true when the KDJ is in the oversold zone. When the J-line is below the others, a BUY could be a good idea.