If you are grappling with getting a handle on this stock market, you aren't alone. On one hand, corporate earnings remain strong: FactSet data reveals that, with nearly all companies reporting as of mid-May, S&P 500 Q1 2026 year-over-year earnings growth was 27.7%, with 84% of companies having reported a positive EPS surprise and 80% reported a positive revenue surprise. On the other hand, inflation has worsened notably in recent months and US consumer sentiment is near record lows.
Despite these risks, stocks are near all-time highs. What might the outlook be over the short term? Based on stochastics, the outlook suggests stocks may be expensive.
What are stochastics?
Stochastics are a momentum measure that ranges from 0 to 100. If you add this indicator to your charts, stochastics can typically be found beneath the price chart.
Stochastics applied to the S&P 500®
Stochastics are made up of 2 lines, which tend to move in tandem. %K (dark green line in the bottom half of the chart above) represents the level of the stock or index's closing price relative to the high and low range over a specified period of time, and %D (orange line in the bottom half of the chart above) attempts to smooth out the %K line by taking a 3-day moving average of the %K line. %D is generally considered the more important of the 2 lines.
The theory behind stochastics is that these lines generate buy or sell signals when closing prices are near recent extreme highs or lows (i.e., sell signals after an uptrend and buy signals after a downtrend). Generally, the area above 80 indicates an overbought region, while the area below 20 is considered an oversold region. When stochastics are above 80 and move below that number, it indicates a sell signal. When stochastics are below 20 and move above that number, it indicates a buy signal. 80 and 20 are the most common signal levels used, but can be adjusted per individual preferences.
Momentum indicators like stochastics are typically considered more valuable in sideways markets, compared with uptrends or downtrends, because of the way they oscillate between relatively overbought and oversold prices.
What are stochastics saying about stocks now?
The S&P 500 has rallied nearly 10% thus far this year. A buy signal was generated in late March, according to this indicator, when stochastics crossed above the 20 reading. Over the past month, fast stochastics for the S&P 500 held above the 80 reading in overbought territory, and recently dropped below 80. This generated a sell signal.
Another pattern that can be observed when using stochastics is a divergence between the direction of the stochastics indicator and a stock or index, such as the S&P 500. Divergences form when a new high or low in price is not confirmed by a new high or low in stochastics. A bullish divergence, for example, forms when price makes a lower low but stochastics form a higher low. This could indicate less downward momentum and could foreshadow a bullish reversal. Active investors may want to monitor stochastics if the S&P 500 pushes higher while the trend for this indicator continues down.
Stochastics and stocks
It's worth noting that, once a trading signal is generated by a technical indicator such as stochastics, that doesn't necessarily mean that signal (to buy or sell) stays in effect until a contrary signal is generated. Rather, it can be thought of as a trading indicator that is relevant for a short period of time (e.g., a few days or weeks) after it is generated.
Also, momentum indicators—including stochastics—can remain above 80 in overbought levels for extended periods after an upturn, without indicating that the security is becoming more overpriced. Similarly, stochastics can remain below 20 in oversold territory for extended periods after a sustained downtrend, without meaning the stock is becoming more oversold.
Of course, you shouldn't take a trading action based solely on this one signal. Like any technical indicator, stochastics are best used in combination with other data points, macroeconomic analysis of the market and business cycle, and, if used with individual stocks, an analysis of earnings and more company fundamentals.