Stochastic
A 0 to 100 score for where price closed inside its recent high and low.
Where did price close?
Here's a simple question: did price close near the top of its recent range, or near the bottom? The answers it with a number from 0 to 100. A trader named George Lane made it popular in the 1950s.
His idea: when buyers are strong, prices tend to close near the top of the recent range. When sellers are strong, prices tend to close near the bottom.
Work one out
Look back over the last 14 candles (the standard setting).
- The highest high was $20.
- The lowest low was $10.
- Today's close is $18.
Where is $18 inside the $10 to $20 range? First, how far is it from the bottom? 18 - 10 = 8. The whole range is 20 - 10 = 10. So:
Stochastic = 8 ÷ 10 × 100 = 80
Price closed 80% of the way up the range. Picture a ladder with 10 rungs: you're standing on rung 8.
The two lines: %K and %D
The number you just worked out is called %K (say "percent K"). Your app draws two lines:
- %K: the faster line. Most apps smooth it a little by averaging the last 3 readings.
- %D: the slower line, an average of the last 3 %K readings.
That's what the common setting 14, 3, 3 means: look back 14 candles, smooth %K over 3, then average it again over 3 to make %D. This version is often called the "slow stochastic."
How traders read it
- Above 80: overbought. Price keeps closing near the top of its recent range.
- Below 20: oversold. Price keeps closing near the bottom.
- Crosses: some traders watch for %K crossing %D, especially above 80 or below 20.
Stochastic and RSI are not the same
They look alike, but they ask different questions. RSI asks, "How big were the up moves compared to the down moves?" Stochastic asks, "Where did price close between its recent high and low?" Stochastic is jumpier, so it gives more signals, and more of them turn out wrong.
Where it fails
In a strong uptrend, price keeps closing near the top of its range, so Stochastic can sit above 80 for a long time. That's a sign of strength, not a sign to sell. And because it's so jumpy, it flips across 80 and 20 often, and many of those flips mean nothing at all.
Remember
- Stochastic shows where the close sits between the recent high and low, from 0 to 100.
- The standard setting is 14, 3, 3.
- Above 80 is overbought. Below 20 is oversold.
- It's fast and jumpy, so it gives lots of false signals, especially in strong trends.
Check yourself
1. Highest high $50, lowest low $40, close $45. What's the Stochastic?
2. What does a reading of 95 mean?
3. In the setting 14, 3, 3, what does the 14 mean?
4. Stochastic stays above 80 for weeks in a strong uptrend. What's the best way to read that?
Next lesson: MACD
Money Tree School is education, not financial advice. Examples use made-up or historical numbers to show how things work; they are not recommendations to buy or sell anything. Markets can lose money.