Stochastic Oscillator
Definition
The Stochastic Oscillator compares a stock’s closing price to its price range over a recent period. The idea is simple: in an uptrend, prices tend to close near the top of the range, and in a downtrend, near the bottom. It produces two lines, %K and %D, both on a 0 to 100 scale. The standard setting is a 14-period lookback with a 3-period smoothing.
Formula
%K = [(Close - Lowest Low) / (Highest High - Lowest Low)] x 100
over the last 14 periods
%D = 3-period simple moving average of %KHow to Interpret It
Like RSI, the Stochastic has overbought and oversold zones — above 80 is overbought, below 20 is oversold. When both %K and %D are above 80, the stock has been closing near the top of its range repeatedly. When both are below 20, it has been closing near the bottom.
The crossover between %K and %D is often used as a timing signal. When %K crosses above %D in the oversold zone, some traders read that as a buy signal. The reverse crossing in the overbought zone is read as a sell signal.
Typical Strategy
The textbook approach is to wait for the Stochastic to enter the oversold zone (below 20) and then buy when %K crosses back above %D. This attempts to catch the turn rather than buying into continued selling.
A second approach combines the Stochastic with trend analysis. In a confirmed uptrend, traders only take the buy signals (oversold crossovers) and ignore the sell signals, using the indicator to find pullback entries within the larger move.