Stochastic oscillator.

Say EUR/USD has traded between 1.0850 and 1.0950 over the last 14 candles, and the latest candle closes at 1.0930. That close sits near the top of the recent range.

The stochastic oscillator turns that position into a number from 0 to 100. Here the number is 80. All prices in this lesson are round illustrative figures.

What does the stochastic oscillator measure?

The stochastic oscillator is a momentum indicator that compares the latest close with the highest high and the lowest low of a set number of candles, called the lookback period. Charts draw it in a panel below price.

It belongs to the family of oscillators, indicators that swing back and forth rather than follow price. The stochastic has fixed limits: a reading can never fall below 0 or rise above 100, on any pair or timeframe.

A close at the very top of the range gives 100. A close at the very bottom gives 0. A close exactly halfway gives 50.

The idea behind it is a habit of markets. In a rising market, closes tend to land near the top of the recent range, and in a falling market near the bottom. When closes stop doing that, the pressure may be fading.

How do you calculate %K and %D?

The main line is %K. Its formula is:

%K = (close − lowest low) ÷ (highest high − lowest low) × 100

Take the EUR/USD example with a 14-candle lookback:

1. The highest high of the last 14 candles is 1.0950.
2. The lowest low of those candles is 1.0850.
3. The range is 1.0950 − 1.0850 = 0.0100, which is 100 pips.
4. The close sits 1.0930 − 1.0850 = 0.0080 above the low, which is 80 pips.
5. %K = 0.0080 ÷ 0.0100 × 100 = 80.

The second line, %D, is a simple moving average of %K, usually over 3 periods. It moves more slowly than %K and is read as the signal line.

Suppose the last three %K readings were 72, 75 and 81. Then %D = (72 + 75 + 81) ÷ 3 = 228 ÷ 3 = 76.

A yen pair uses the same sum, with 0.01 as the pip. Say USD/JPY's 14-candle high is 151.00, its low 149.00 and its close 149.30.

The range is 2.00, or 200 pips. The close sits 0.30, or 30 pips, above the low. So %K = 0.30 ÷ 2.00 × 100 = 15.

Only the close's position inside the range counts, so a quiet pair and a volatile pair can show the same reading.

What are the fast, slow and full versions?

Raw %K jumps around because one new candle can change the high, the low and the close at the same time. Platforms offer smoothed versions to calm it down.

• The fast stochastic plots raw %K, with %D as its 3-period average.
• The slow stochastic takes that %D as its new %K, then averages it again over 3 periods for its own %D.
• The full stochastic lets you choose all three numbers yourself.

A setting written 14, 3, 3 means a 14-candle lookback, %K smoothed over 3 periods, and %D averaged over 3 more. That full stochastic matches the slow version, and it is a common starting point.

MetaTrader names the %K smoothing field Slowing. Defaults differ between platforms, so check the settings window before you compare two charts.

A shorter lookback reacts faster and produces more signals, many of them noise. A longer lookback is calmer and slower to turn.

What do overbought and oversold mean?

Most stochastic panels show two guide lines, at 80 and 20. A reading above 80 is called overbought, and a reading below 20 is called oversold.

Both words describe where recent closes sat. Overbought means near the top of the recent range. It makes no claim that price is too high or due to fall.

The textbook signals are crossovers between the two lines:

• %K crossing below %D while both are above 80, read as upward momentum turning down.
• %K crossing above %D while both are below 20, read as downward momentum turning up.

A stricter version of the rule waits until the line leaves the zone, such as %K dropping back below 80. That filters some false signals and makes the rest arrive later.

The stochastic is also compared with price. If price makes a higher high while the stochastic makes a lower high, the mismatch is called divergence.

It hints that the push may be weakening, and it can last a long time before price turns, if it turns at all.

Where does the stochastic oscillator fail?

In a strong trend the stochastic can stay above 80, or below 20, for a long run of candles. Selling each overbought reading in an uptrend means selling again and again into a market that keeps rising.

The chart below is illustrative. EUR/USD climbs toward 1.1000 while %K stays above 80 for the last 8 candles.

Overbought and oversold readings are usually taught as more useful when price moves sideways. The lesson on trending and ranging markets shows how to tell the two apart.

The ADX, later in this module, measures how strong a trend is, which helps you judge whether an overbought reading means much.

The indicator lags too. In the slow version, %D is an average of an average, so a crossover usually shows up after a turn has already started.

Fast markets cause whipsaws, where the lines cross back and forth around 80 or 20 and every cross looks like a signal. A shorter lookback makes this worse.

The evidence that the basic 80 and 20 rules make money on their own, after spread and commission, is weak.

Treat any setting as an idea to test, first with backtesting and then on a demo account, before real money is involved.

The next lesson, the RSI, is another 0 to 100 oscillator. It is built from the average size of up and down moves between closes, where the stochastic uses the high to low range.