Stochastic Oscillator

What is the stochastic oscillator?

The stochastic oscillator is a momentum indicator that measures where the current close sits between the lowest low and highest high of a lookback window, most commonly 14 periods. Raw %K places that position on a 0-to-100 scale, and %D is a moving average of %K that serves as its signal line.

For a positive range, %K = 100 × (close − lowest low) / (highest high − lowest low). Include the current observation in both extrema. A close at the high gives 100, at the low gives 0 and halfway between gives 50.

Fast vs slow stochastic settings

Fast stochastic plots raw %K and its signal average. The SMA-smoothed slow version uses a three-period SMA of raw %K as slow %K, then a three-period SMA of slow %K as slow %D.

Specify the lookback, first smoothing, signal length and averaging method. In the 14/1/3 fast chart, the first smoothing length is one and %D uses three observations.

Some platforms average the raw %K readings; others divide the summed close-minus-low values by the summed ranges. The results part ways when the ranges vary, so match the method before you compare readings across platforms.

Stochastic overbought, oversold and crossover signals

Raw %K above 80 places the close in the range’s upper fifth; below 20 places it in the lower fifth. Smoothed readings describe averages of prior raw readings.

On the chart, %K crosses below %D on bar 7, at 77.78 versus 84.72. It crosses back above on bar 10, at 66.67 versus 55.56.

Define whether a crossing qualifies a pullback, breakout or reversal setup. Match the event with the price structure and set the decision bar, entry and invalidation. Run the crossing’s price target and expected date through the Options Profit Calculator, and the payoff across dates shows how much each structure gives back to time decay if the move runs late.

Limitations of the stochastic oscillator

• The reading places the close in the range, whatever the range’s size. The example’s 80 sits $6.40 above the low of an $8 range; check the range in dollars before you size the trade.
• When an uptrend is strong, the close stays near the top of the range and %K holds above 80 for many bars; a strong downtrend holds it below 20. Read 80 in an uptrend as strength, and wait for the price structure to break before you fade it.
• Smoothing adds lag, so slow %K and %D trail raw %K. When price chops sideways, the lines cross back and forth; let the price structure confirm a crossing before you act.
• Lookback, smoothing lengths and averaging method all move the lines, so match all three before you compare two charts.

Bottom line

The stochastic oscillator shows where the close sits within its recent high-low range, and %D smooths that reading into a signal line. State the lookback and smoothing, read 80 and 20 as positions in the range rather than reversal calls, and confirm a crossover with the price structure before acting on it.