Stochastic was originally an engineering term and relates to what the value is relative to what it has been. The Stochastic uses a 0 to 100% scale. If it is 0, then (after averaging) it is the cheapest it has been it 5 days. If it 100% (after averaging), then it is the most expensive it has been in 5 days. When a stock price moves up, it does so in a zig zag fashion. The price will move up to a higher peak then fall down to a trough. To continue the trend, we want the stock to get to a higher price than previous peak and establish a new higher peak. By doing so, the stock will stay close to the most expensive price it has been recently, if not the most expensive it has been. With our stochastic, this means a value of around 75 to 100%.

To calculate the Stochastic, we first subtract the lowest low during the last 5 days from today’s close. CL = Close (today) – Lowest Low We then take the lowest low from the highest high to give us a range for those 5 days. HL = Highest High – Lowest Low These two figures are then expressed as a ratio. Stochastic = CL / HL x 100% To smooth this line, we then calculate a 5 day moving average of this value and this is what we see on the graph. When the Stochastic line crosses up through 25%, the Stochastic is bullish. If the line then crosses back down through 25%, it becomes bearish again. When this Stochastic line crosses down through 75%, then the Stochastic is bearish. If the line then crosses back above 75%, it becomes bullish again.

Returning to the example, we can see that the share price was slowly falling. This means that overall the price was cheaper every day on average. As a result, the Stochastic line was below 25% and bearish. The share price then went through a very short rally before falling back to the previous low price. Similarly, the Stochastic rose and then fell back again. The share price then entered the uptrend we have already discussed with the MACD. The price rose and the Stochastic quickly followed. While new highs are being reached, the Stochastic stays above the 75% line. Once the price rally is over though, the Stochastic quickly crosses back down through the 75% line and becomes bearish.