Stochastic oscillator

The stochastic oscillator, associated with George Lane, compares the latest close with the range of prices over a lookback period, usually 14. The idea is that in a rising market closes tend to be near the top of the recent range, and in a falling market near the bottom.

• %K = (close − lowest low) ÷ (highest high − lowest low) × 100
• %D = a moving average of %K, usually 3 periods, used as a signal line

Readings above 80 are commonly labelled overbought and below 20 oversold. The "slow" stochastic, which smooths %K before calculating %D, is the default on many platforms.

Example

Illustrative figures on a GBP/USD four-hour chart over the last 14 bars: the highest high is 1.2750, the lowest low is 1.2650 and the latest close is 1.2730.

• Range: 1.2750 − 1.2650 = 0.0100
• Close above the low: 1.2730 − 1.2650 = 0.0080
• %K = 0.0080 ÷ 0.0100 × 100 = 80

The close sits 80% of the way up the recent range. If the next bar closes at 1.2680 with the same high and low, %K drops to 30.

Common misconception

An overbought reading does not mean the price must fall. In a strong uptrend the stochastic can stay above 80 for long periods, because each close keeps landing near the top of the range. Selling every time it crosses 80 means fighting the trend.

Traders more often use it to look for divergence, where price makes a new high but the oscillator does not, or to time entries in the direction of an established trend. It behaves similarly to the RSI; our guide to RSI and MACD covers how momentum indicators are used and misused.