An oscillator that works best exactly where trend indicators break down — in a sideways market. Here is what the %K and %D lines show and how to catch reversals at the range edges.
An oscillator from 0 to 100: where a candle closed relative to the high and low of the last 14 candles.
Lines
%K is the fast line, %D its 3-candle smoothed version.
Where it works
In a range: a reversal at the top when it leaves the 80 zone, at the bottom when it leaves the 20 zone.
Where it fails
In a trend the indicator gets stuck in an extreme zone and gives false reversals.
What it is
The stochastic answers a simple question: is price closing nearer the top or the bottom of its recent range? If a candle closes right at the high of the last 14 candles, %K is close to 100; at the low, close to 0.
%D is a smoothed %K. Crosses of the two lines in the extreme zones are the signals.
Why it's good in a range
In a sideways market price travels between two levels. The stochastic shows well when the push toward an edge has run out: the indicator was above 80 and then turned down — buyers can no longer close candles near the highs.
A range: reversals at the edges line up with the stochastic leaving the 80 and 20 zones. Illustrative data.
How to use it
01
Make sure it's a range
Price has bounced off the same levels several times and the moving averages are flat.
02
Wait for price at an edge
Signals in the middle of the range aren't traded.
03
Look for the exit from the zone
At the top %K and %D drop out of the 80 zone; at the bottom they rise out of the 20 zone.
04
Stop beyond the edge
Beyond the range high or low with a small margin.
05
Target the opposite edge
Or the middle of the range if it's narrow.
Once price breaks a range edge and holds beyond it, the stochastic stops working: the market has switched to a trend. "Overbought" signals at that point pull you against the new move.
Common mistakes
Using the stochastic in a trend
In a trend it stays in an extreme zone for a long time. Moving averages are the tool for trends.
Entering on a signal in the middle of the range
Strong signals come only at the edges, where a level confirms them.
Confusing the stochastic with RSI
Both are oscillators, but the stochastic compares the close with the range while RSI compares the strength of gains and losses. The stochastic is faster and noisier.
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