The Schaff trend cycle (STC) is a forward-looking, leading indicator that generates faster, more accurate signals than other indicators, suchas the MACD because it considers both time (through cycles) and moving averages.
The Schaff trend cycle (STC) is commonly usedto identify market trends and provide buy and sell signals to traders.
Schaff trend cycle is a type of oscillatorand is based on the assumption that, regardless of time frame, trends accelerate and deceleratein cyclical patterns.
Many traders are familiar with the MACD chartingtool, which is an indicator that is used to forecast price action and is notorious forlagging due to its slow responsive signal line.
By contrast, STC’s signal line enables itto detect trends sooner.
In fact, it typically identifies up and downtrendslong before MACD indicator.
While the Schaff trend cycle is computed usingthe same exponential moving averages as MACD, it adds a novel cycle component to improveaccuracy and reliability.
While MACD is simply computed using a seriesof moving average, the cycle aspect of STC is based on time (for example, number of days).
Although STC was developed primarily for currencymarkets, it may be effectively employed across all markets.
It can be applied to intraday charts, suchas five minutes or one hour charts, as well as daily, weekly, or monthly time frames.
What makes this indicator interesting is thatit is a combination of MACD and fast stochastics with a cycle component and a smoother to capturemarket prices more comprehensively.
It’s basically a combination of leadingand lagging indicators.
So let’s discuss the main problems of MACDand stochastic.
The MACD follows prices with its 12- and 26-periodexponential moving average (EMA) components and nine-day EMA signal line.
In this capacity, it is a trend indicator.
Yet it is lagging because it doesn’t alwayslead prices and is prone to false signals especially in fast-moving markets.
So you have to adjust the settings to satisfyyour price and market objectives.
The stochastic is also lagging.
The problem with stochastic is its abilityto generate false signals, while markets can take off before signals are generated.
Part of the problem with stochastic oscillatoris its concentration on the 3-day simple moving average as the signal line.
False signals and slow reactions are justthe beginning of problems, especially for short-term and day traders because the three-daysimple moving average is too short a term to represent fast markets and act as a truetrigger line.
The Schaff trend cycle (STC) indicator triesto fix these problems by incorporating a shorter-term EMA set with a default at 23 with a longer-termEMA with a default at 50.
This remedies the MACD and fast stochasticfalse signal.
This combination can be employed to capturetrends, but it doesn’t incorporate entries and exits fully.
To fix this, a signal was needed.
The MACD’s nine-day exponential signal linewas not always effective, while fast stochastic %d signal line was also a failure.
You need a true signal that would capturea true trend.
This came from cycle theory, a theory neverfully incorporated into an indicator.
This signal line was derived from theoriesand practices of 10-, 20-, and 40-day currency cycles.
The halfway point between the 23- and 50-dayEMA is, in cycle theory, 10 so the cycle default is set as a standard 10.
But this cycle can also be viewed as a halfwaypoint of a 20-day cycle as well.
This is the signal line that denotes trends, ranges, or congestion.
The developer of this indicator consideredthat currency cycles generally come in 10-, 20-, and 40-day cycles.
These are measured by daily and weekly candlesticks.
In addition, you must know that not all highsare cycle highs and not all lows are cycle lows.
One of the problems with the STC indicatoris that the signal line can get stuck in overbought or oversold territories for extended periods.
This is because cycles haven’t completedtheir time.
But, we’ll discuss these problems later.
So how does it work? The main idea behind this oscillator is tocombine the benefits of trend and cycle indicators and minimize their drawbacks such as lagsor false signals.
The main goal of the STC is to identify orconfirm price direction and market turning points.
Here is how to understand its readings.
There are two thresholds: 25 and 75.
When the indicator crosses above the 25 line, an uptrend is observed.
When the indicator crosses below the 75 line, a downtrend is believed to be present.
When the indicator is between the 25 and the75 lines, the trend is developing in one of these two directions.
When the indicator turns into a straight line(which only happens in its uppermost and lowermost points), the asset is either overbought — whenabove the 75 line, or oversold — when below the 25 line.
In both cases, a trend reversal can be expected, but no exact time timeline is provided.
How to apply the STC indicator in trading? The Schaff trend cycle (STC) is a pretty straightforwardindicator, as there are not so many ways in which it can be used.
And remember, though originally designed forforex trading, it can be effectively applied to all asset types and on all time frames.
Here’s how traders usually use Schaff trendcycle.
When the indicator goes above the 25 line, the trend is believed to be taking a positive turn (according to the indicator).
It is when traders consider opening a buyposition, but only if the confirmation is received.
For example, a candle after current one thatmoves in the same direction can be considered a confirmation.
Readings of other indicators that go in linewith STC can also be treated as a confirmation.
The same rules apply to negative trends.
When the indicator goes below the 75, sometraders consider opening a sell position, of course with confirmation.
STC is a leading indicator, which means thatit sends a signal before the price move has occurred.
It also means that it lacks the accuracy oflagging indicators and should be used in conjunction with other technical analysis tools, neveron its own.
So, buy and sell signals are generated whenthe signal line breaches 25 at the bottom and 75 at the top.
When the signal line breaches 25 and is headingup, this is a possible buy, or a long position, when the signal line breaches 75 and is pointingdown, this is a potential short.
One exit possibility is when the short tradehits the bottom and breaches the 25 level and when the long trade hits the top and breaches75 level.
But if the signal line is pointing in theright direction, you may choose to stay in the trade since currencies can easily trendto the high 90 level at the top and near zero at the bottom.
It is a good idea to find confirmation throughcandles.
Before the long position, make sure you havean upward candle and a downward candle for shorts.
Doug Schaff, the developer of the indicator, recommended a confirmation by entering on the second candle up for longs and the secondcandle down for shorts.
Simple price action, like paying attentionat market swings like higher highs and higher lows are even better.
Looking at this Tesla chart, we can firstapply the trend filter, in this case an uptrend, and look to take only buy signals, when theindicator breaches 25.
We had some decent signals just by payingattention to the main trend.
The same for a downtrend.
We have lower lows and lower highs, so wetake only shorts when the STC crosses below 75.
Here are a few trade examples using Schafftrend cycle indicator.
Settings can be adjusted according to varioustime frames.
For example, Schaff recommended you try smallerEMAs for longer time frames and longer EMAs for shorter time frames.
The smaller the number used for cycles, themore turns you will witness while the higher numbers will forecast fewer turns with morecycle accuracy.
What you want from adjustments is for thesignal line to perfectly follow prices and candles.
While I find this indicator to be reliablewhen the signal is caught correctly, there is one problem.
The signal can stay in overbought or oversoldconditions for extended periods.
So you need to have an alternative exit plan, maybe a trailing stop, or a fib target, to get the most profit out of your trade.
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