Stochastic
Stochastic Oscillator
The Stochastic Oscillator compares a stock's closing price to its price range over a given time period. Developed by George Lane, it is used to identify overbought and oversold conditions.
How It Works
It measures where the current closing price is relative to the high-low range over N periods. Values near 100 indicate price is near recent highs; near 0 means price is near recent lows.
Formula
%K = (Current Close - Lowest Low) / (Highest High - Lowest Low) × 100 %D = 3-period SMA of %K (signal line)
Signal Interpretation
Both %K and %D above 80 suggest overbought conditions — potential reversal or pullback.
Both %K and %D below 20 suggest oversold conditions — potential bounce or reversal.
%K crossing above %D in oversold zone = bullish. %K crossing below %D in overbought zone = bearish.
Use Cases
- ▸Short-term counter-trend trading
- ▸Confirming RSI signals
- ▸Finding reversals at key support/resistance
Limitations
- ⚠Generates many false signals in trending markets
- ⚠More effective in range-bound markets
- ⚠Should not be used alone for trading decisions
The Stochastic is most effective when used alongside support/resistance levels and a trend indicator like MACD to filter signals.