Stochastic Oscillator
Measures where the closing price sits within a recent high-low range, generating overbought/oversold readings and crossover signals.
Description
The Stochastic Oscillator was developed by George Lane in the 1950s. It is based on the observation that in uptrending markets, closing prices tend to cluster near the highs of the recent range, and in downtrending markets, near the lows. The indicator measures where the current close sits within the recent range, scaled to 0–100.
How It Works
%K = (close − N-period low) / (N-period high − N-period low) × 100. Default N = 14. This raw value is often smoothed by a 3-period SMA to produce the displayed %K line. %D is a 3-period SMA of %K, functioning as a signal line. The result is “Fast Stochastic.” “Slow Stochastic” smooths %K with an additional SMA, making it less noisy.
How to Read It
Readings above 80 are considered overbought; below 20 are oversold. The primary signals are: %K crossing above %D in oversold territory (buy); %K crossing below %D in overbought territory (sell). Divergence between Stochastic and price also signals potential reversals. In uptrends, oversold Stochastic readings can mark pullback entries rather than reversal points.
Common Uses
- Overbought/oversold identification in ranging markets
- Crossover signals between %K and %D
- Divergence analysis for reversal warnings
- Combining with trend filters to avoid counter-trend signals
Caveats
The Stochastic is highly sensitive and stays overbought or oversold for extended periods during trending markets. Applying it mechanically as a reversal tool in trending conditions produces heavy losses. It performs best when price is ranging — oscillating between defined support and resistance. Always use a trend filter to avoid fading strong trends.