KDJ Tutorial: Master this "Retail Investor's Triple Treasure" Indicator from Scratch

As a trader, you must have heard of the KDJ indicator. This technical tool, known as one of the “Three Treasures of Retail Investors,” why has it become widely popular among traders? This article will start from basic concepts, guiding you to a deep understanding of the core points of KDJ teaching, and how to flexibly apply it in actual trading.

What exactly is the KDJ indicator?

The KDJ indicator, also called the stochastic indicator, is a powerful tool used in technical analysis to discover market trends and optimal entry points.

On the KDJ chart, you will see three lines, representing:

• K value (fast line): Measures the relationship between the closing price of the day and the price fluctuations over a past period
• D value (slow line): Smoothed version of the K line, aimed at eliminating market noise
• J value (sensitive line): Reflects the deviation between K and D values

The K and D lines are used to determine overbought or oversold conditions, while the J line’s volatility indicates changes in market sensitivity. When these three lines cross, it usually signals the arrival of new trading opportunities.

According to the basic theory of KDJ teaching: When the K line crosses above the D line, it indicates an upward trend, and buying can be considered; conversely, when the K line crosses below the D line, the market enters a downward trend, and selling should be considered.

The logic and calculation basis of KDJ

The KDJ indicator is derived by calculating the ratio of the highest, lowest, and closing prices over a specific period to obtain the Unfinished Stochastic Value (RSV), then using a smoothing moving average method to compute the K, D, and J values, which are finally plotted as a trend chart for analysis.

Brief calculation steps

Step 1: Calculate RSV

For daily data, the formula for RSV is:

RSVn= (Cn - Ln) ÷ (Hn - Ln) × 100

Where:

• Cn = closing price on day n
• Ln = lowest price over the past n days
• Hn = highest price over the past n days

RSV always fluctuates between 0 and 100.

Step 2: Calculate K, D, J values

• Today’s K = 2/3 × previous day’s K + 1/3 × RSV
• Today’s D = 2/3 × previous day’s D + 1/3 × K
• Today’s J = 3 × K - 2 × D

If there is no previous data, 50 can be used as the starting value.

In actual operation, you don’t need to manually calculate these formulas; trading platforms will do it automatically. You just need to adjust the time period according to your needs.

Parameter settings and practical application of KDJ teaching

How to set KDJ parameters

The default parameters for KDJ are usually (9,3,3), meaning calculations are based on the past 9 days’ price data. The higher the parameter values, the less sensitive the indicator is to price fluctuations; vice versa. In most cases, the default parameters are sufficient for daily trading analysis.

Practical application methods

1. Judging overbought and oversold ranges

Setting two horizontal reference lines—80 and 20—on the KDJ chart can help you quickly determine overbought and oversold conditions:

• When K and D rise above 80, it indicates the stock price has entered an overbought zone, possibly facing a pullback risk
• When K and D fall below 20, it indicates the stock price has entered an oversold zone, with potential rebound opportunities

Additionally, you can observe the amplitude changes of the J line. J > 100 indicates overbought, J < 10 indicates oversold.

2. Four classic trading signals

The four most important trading signals in KDJ teaching are:

Specific manifestation of the Golden Cross: When K and D lines are both in the oversold zone below 20, and K crosses above D, this is called a “low-level Golden Cross.” At this point, the market’s bearish force is extremely weak, and the bulls are about to launch a counterattack. After this pattern appears, stocks usually enter an upward trend, making it a more reliable buying opportunity.

Specific manifestation of the Death Cross: When K and D lines are both in the overbought zone above 80, and K crosses below D, this is called a “high-level Death Cross.” At this point, the market’s bullish momentum is about to exhaust, and a reversal downward is imminent. This pattern indicates a potential trend reversal and is a more reliable sell signal.

3. Application of divergence patterns

Top Divergence: When the stock price makes higher highs, but the KDJ values make lower highs, this divergence often signals a market top. The upward trend may be ending, and investors should prepare to sell.

Bottom Divergence: When the stock price makes lower lows, but the KDJ values make higher lows, this divergence indicates a potential bottoming out and rebound opportunity. Investors can consider buying on dips.

Recognizing top and bottom formations with KDJ

Besides the signals above, KDJ can also help identify important top and bottom formations.

Double Bottom Pattern (W bottom)

When the KDJ indicator operates below 50 and the curve shows a W shape or triple bottom reversal pattern, it indicates the stock price is about to shift from weakness to strength. The more times a bottom appears, the larger the subsequent upward movement tends to be.

Double Top Pattern (M top)

When the KDJ indicator operates above 80 and the curve shows an M shape or triple top reversal pattern, it indicates the stock price is about to reverse downward. The more times a top appears, the larger the subsequent decline tends to be.

Practical case: KDJ application on the 2016 Hong Kong Hang Seng Index

To better understand the practical application of KDJ teaching, let’s analyze a real market case.

On February 12, 2016, the Hong Kong Hang Seng Index experienced a sharp decline. At this time, ordinary investors felt disappointed, but attentive traders noticed a different signal—although the price made a lower low, the KDJ indicator showed a bottom divergence pattern with a higher low. This is regarded as an extremely valuable entry opportunity in KDJ teaching.

By February 19, the Hang Seng Index opened sharply higher, rising 965 points in a single day, a 5.27% increase. Investors who identified the bottom divergence successfully caught the start of the rally.

On February 26, the K line crossed above the D line from below, forming a low-level Golden Cross. Traders added positions at this signal, and the Hang Seng surged another 4.20%, further confirming the effectiveness of the KDJ indicator.

On April 29, a high-level Death Cross appeared with K and D lines above 80. Traders exited positions at this point, locking in profits.

On December 30, the KDJ showed a double bottom pattern. Traders bought the dip again, and the bull market officially started. Although there was a top divergence signal during this period, the continued strong volume and D values remaining above 80 allowed traders to hold positions and continue profiting.

On February 2, 2018, the KDJ simultaneously showed a high-level Death Cross and a triple top pattern. Traders quickly exited, maximizing profits for the entire cycle.

Limitations of the KDJ indicator

Although KDJ is a powerful technical tool, you must recognize its shortcomings:

Indicator dulling: In extremely strong or weak markets, KDJ may give premature buy or sell signals, leading to frequent stop-losses. This increases trading costs and psychological pressure.

Signal lag: KDJ is based on historical price data and cannot fully predict rapid market changes. When sudden events occur, the indicator may respond slowly.

Lack of independence: KDJ should not be the sole basis for trading decisions; it needs to be combined with other technical indicators or fundamental analysis for more reliable judgments.

Prone to false signals: During sideways or choppy markets, KDJ can produce misleading signals, especially in periods of low volatility.

Core summary of KDJ teaching

The KDJ indicator is an important tool in technical analysis, helping traders identify trends and trading opportunities effectively. But no indicator is perfect; the key is to maximize KDJ’s advantages in practice while using experience to avoid its shortcomings.

The best trading strategy is to combine KDJ with candlestick patterns, volume, and other technical indicators to form a multi-dimensional analysis framework. This approach can effectively reduce investment risks and improve trading success rates.

In your trading journey, you should not only learn how to use KDJ but also continuously accumulate experience through live trading and simulation. Only by understanding both yourself and the market can you achieve victory in the market.