When looking to use the stochastic oscillator for trading signals, it is advised that you wait for the moving average lines to cross over each other after they have moved into the overbought or oversold zones.
If the lines move below 20 and then rise and cross back above 20, this would be a bullish signal and a long trade could be considered.
As a trader, you can decide to change the stochastic oscillator’s parameters to suit your trading style.
However, it is important to note that it is vital to test whatever settings you decide to use.
The standard settings used that indicate an overbought zone are between 80 and 100, while the oversold zone is found between 0 and 20.
By lowering the overbought zones level to 70 or raising the oversold zone to 30, you would find the indicator giving overbought or oversold signals much faster. This would allow you to get into the trade sooner, but the downside is that it would also increase the number of false signals given, leading to more losing trades.
For %K: There’s often an additional smoothing period applied to %K, generally set to 3 bars by default. This further smooths out the calculation to reduce volatility and potential false signals.
Now, Raising the indicator’s setting to speed up the lines will cause them to enter the overbought or oversold zones much faster. This will generate more trading signals, however there will be more false signals generated, which can lead to regular losses.
This can make any kind of profitable trading difficult to sustain.
On the other hand, if you were to decrease these settings, it would have the opposite effect, causing the lines to move less frequently between the overbought and oversold zones. You will have to wait longer for the stochastic to generate an entry signal if the sensitivity of the indicator has been decreased. The downside to this is it can lead to missed trading opportunities.
When changing any parameters of the stochastic oscillator, it is important that you test whether these changes actually improve or worsen your trading results.
As usual, the target level has been written arbitrarily here.