In this illustrated guide, we explain what Stochastics indicate in charts. We begin by distinguishing between fast and slow Stochastics.
Once you’ve understood the Stochastics formulas, you can read on to find out how to interpret a chart with Stochastics analytics and how you can use it to find potential buy and sell signals to plan your entry and exit strategies.
What Are Stochastics?
The Stochastic technical analysis indicator might be helpful in detecting price divergences and confirming trend.
Here are the basics on the two types of Stochastic Indicators:
What Is The Stochastic Fast?
Stochastic Fast plots the location of the current price in relation to the range of a certain number of prior bars (dependent upon user-input, usually 14-periods).
In general, stochastics are used in an attempt to uncover overbought and oversold conditions.
Above 80 is generally considered overbought and below 20 is considered oversold.
The Stochastic Fast Formula
The inputs to Stochastic Fast are as follows:
- Fast %K: [(Close – Low) / (High – Low)] x 100
- Fast %D: Simple moving average of Fast K (usually 3-period moving average)
What Is The Stochastic Slow?
Stochastic Slow is similar in calculation and interpretation to Stochastic Fast.
The Stochastic Slow might be viewed as superior due to the smoothing effects of the moving averages which equates to less false potential buy and sell signals.
The Stochastic Slow Formula
- Slow %K: Equal to Fast %D (i.e. 3-period moving average of Fast %K)
- Slow %D: A moving average (again, usually 3-period) of Slow %K
How To Spot Stochastics Buy & Sell Signals
The next sections discuss potential buy and sell signals and how stochastics may outline areas of overbought or oversold price conditions.
Be sure to use the example charts to get a visual overview of the technique’s applicability.
Stochastics Potential Buy Signal
A trader might interpret a buy signal when the Stochastic is below the 20 oversold line and the %K line crosses over the %D line.
Stochastics Potential Sell Signal
A trader might interpret a sell signal when the Stochastic is above the 80 overbought line and the %K line crosses below the %D line, sell.
An example of possible Stochastic Fast buy and sell signals are illustrated below in the chart of the E-mini S&P 500 Future:
Stochastic Slow Signal On Futures
Stochastic Slow is presented below in the chart of the E-mini Russell 2000 Futures contract.
Notice how much smoother the %K and %D lines are and how many fewer false signals were given by the Stochastic Slow than were given by the Stochastic Fast indicator.
How To Find Stochastic Price Divergences
The Stochastic technical analysis indicator might be helpful in detecting price divergences and confirming trends.
In the below example of the Nasdaq 100 ETF (QQQQ), the Stochastic indicator spent most of its time in an overbought area.
When Stochastics get stuck in the overbought area, like at the very right of the chart, this might be a sign of a strong bullish run.
Signals to sell short might be ignored by a trader; however, before the signal not to short was given, many losses may have accrued from failed shorting attempts on the left half of the chart.
What Does Low #1 to Low #2 Show?
The Stochastic Slow confirmed the upward movement of gold futures prices by making a higher low.
What Does High #1 to High #2 Show?
Gold futures rallied to make a higher high; however, the Stochastic Slow indicator failed to make a higher high, instead, it made a lower high.
This divergence coupled with a trendline break in the price of gold may have acted as a strong warning to futures traders.
It may indicate that the recent rally had probably ended and any long futures positions might be exited or at least scaled back.
What Does Low #3 to Low #4 Show?
Gold prices continued its downward tumble, making a lower low at Low #4. On the other hand, the Stochastic Slow indicator was signaling a higher low.
This bullish divergence may have warned traders to exit their shortsells, traders may have interpreted that the price of gold had a strong potential of bottoming.
If you found this Stochastics guide helpful, you may want to learn about the Stochastic RSI.
Where Can I Use Stochastics To Trade?
If you are interested in trading using technical analysis, have a look at our reviews of these regulated brokers available in to learn which charting & analysis tools they offer:
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74%-89% of retail investor accounts lose money when trading CFDs. You should consider whether you can afford to take the high risk of losing your money.
Learn more about technical analysis indicators, charting concepts, and strategies including Momentum, Market Thrust, the Advanced Decline Ratio, Moving Averages, Exponential Ribbons, and Average Directional Movement.
If you’d like a primer on how to trade commodities in general, please see our introduction to commodity trading here.