Pick The Right Settings On Your Stochastic Oscillator (SPY, AAL).

Selecting The Ideal Setups

Pick the most efficient variables for your trading design by deciding just how much noise you’re prepared to accept with the data.

SPDR S&P 500 Count On (SPY) shows various Stochastics impacts, depending on variables.

  • Fast K% – measures the closing price compared to specified lookback periods.
  • Full K% or K% slows down Fast K% with a Simple Moving Average (SMA).
  • Full D% or D% adds a second smoothing average.
  • Lower Fast K%, K% and D% variables =  a shorter-term lookback period with less smoothing
  • Higher Fast K%, K% and D% variables = a longer-term lookback period with greater smoothing

Shorter term variables elicit earlier signals with greater noise levels while longer term variables generate later signals with lower sound levels, except at significant market transforms when time frameworks tend to line up, causing identically-timed signals throughout significant inputs.

Choose the most effective variables for your trading style by deciding how much noise you’re willing to accept with the data. Understand that whatever you choose, the more experience you have with the indicator will improve your recognition of reliable signals. Short-term market players tend to choose low settings for all variables because it gives them earlier signals in the highly competitive intraday market environment. Long-term market timers tend to choose high settings for all variables because the highly smoothed output only reacts to major changes in price action. (For related reading, see: Stochastics: An Accurate Buy and Sell Indicator).

Pick The Right Settings On Your Stochastic Oscillator (SPY, AAL)

SPDR S&P 500 Trust (SPY) shows different Stochastics footprints, depending on variables. Cycle turns occur when the fast line crosses the slow line after reaching the overbought or oversold level. (As outlined in: Use Weekly Stochastics To Time The Market Effectively). The responsive 5,3,3 setting flips buy and sell cycles frequently, often without the lines reaching overbought or oversold levels. The mid-range 21,7,7 setting looks back at a longer period but keeps smoothing at relatively low levels, yielding wider swings that generate fewer buy and sell signals. The long-term 21,14,14 setting takes a giant step back, signaling cycle turns rarely and only near key market turning points.

Shorter term variables elicit earlier signals with higher noise levels while longer term variables elicit later signals with lower noise levels, except at major market turns when time frames tend to line up, triggering identically-timed signals across major inputs. You can see this happen at the October low, where the blue rectangle highlights bullish crossovers on all three versions of the indicator. These large cycle crossovers tell us that settings are less important at major turning points than our skill in filtering noise levels and reacting to new cycles. From a logistical standpoint, this often means closing out trend following positions and executing fading strategies that buy pullbacks or sell rallies. (For more, see: What are the best indicators to identify overbought and oversold stocks?).

Stochastics and Pattern Analysis

Stochastics don't have to reach extreme levels to evoke reliable signals, especially when the price pattern shows natural barriers. While the most profound turns are expected at overbought or oversold levels, crosses within the center of the panel can be trusted as long as notable support or resistance levels line up. Moving averages, gaps, trendlines or Fibonacci retracements will often intercede, shortening a cycle’s duration and flipping power to the other side. This highlights the importance of reading the price pattern at the same time you interpret the indicator. (To learn more, read: Introduction To Technical Analysis Price Patterns). 

Pick The Right Settings On Your Stochastic Oscillator (SPY, AAL)

American Airlines Group (AAL) rallied above the 50-day EMA after a volatile decline and settled at new support (1), forcing the indicator to turn higher before reaching the oversold level. It broke out above a 2-month trendline and pulled back (2), triggering a bullish crossover at the midpoint of the panel. The subsequent rally reversed at 44, yielding a pullback that finds support at the 50-day EMA (3), triggering a third bullish turn above the oversold line. (See also: Strategies & Applications Behind The 50-Day EMA). 

The Bottom Line

Many traders fail to tap into the power of Stochastics because they are confused about getting the right settings for their market strategies. These helpful tips will remedy that fear and help unlock more potential. 

Tip: For investors’ reference only, it does not constitute investment advice. Financial investment products have high risks and are not suitable for every investor. If necessary, please consult a professional consultant.