Best Forex Trading Systems

               

Introducing the Schaff Trend Cycle (STC)

Copyright FX-Strategy.com © 2001

The first step to making a currency trading decision is to identify a market trend. The earlier you can confirm a trend the better. Traders are constantly looking for a better way to do this, a better trend indicator, one that identifies trend faster, without giving up accuracy. This tradeoff between speed and reliability is a continual challenge for currency analysts. The Schaff Trend Cycle Indicator™ (STC) was developed to improve upon the speed and accuracy of the MACD in identifying trends. It is calculated by running a MACD Line (the difference between two exponential moving averages) through a reworked stochastic algorithm.

I use the STC to find cycles within a trend. The peaks and troughs within these “trend cycles” can help identify trends, and pinpoint low-risk trading opportunities -- buying within uptrends, and selling within downtrends.

The STC is also a useful overbought / oversold indicator in sideways markets.
Chart 1 GBP/USD Six Hour Chart: 4/23/02 – 5/21/02
The Schaff Trend Cycle Indicator identifies trend cycle highs and lows.

Comparing the STC to the MACD

The STC cycles or “oscillates” within a fixed scale of 0 to 100. Dotted lines are drawn horizontally at 25 and 75, and are called the 25-line and 75-line or “buy” and “sell” lines, respectively.

The STC generally turns up from below the 25-line, significantly sooner than the MACD crosses above the MACD Signal Line, giving traders an earlier indication of the direction of the market.

The same is true on the sell side. The STC generally turns down from above the 75-line before the MACD crosses below the Signal Line.

Chart 2 shows the reaction of the Schaff Trend Cycle and the MACD indicators to price changes in the hourly Dollar-Yen market. In each case, the STC turns up or down earlier than the MACD crossover, by 3 to 5 hours. More importantly, the STC turns at better trading prices, ranging from 12 to 60 points.1

Making trading decisions on the basis of the STC would have resulted in significantly better trading prices and earlier market entry than the MACD.
1 These results are representative of the STC and MACD in most currencies and timeframes. 		Reaction of the STC and the MACD in the USD/JPY Market

Chart 2 USD/JPY Hourly Chart: 5/13/02 – 5/16/02
Yellow price bars show points where the STC rose above the buy line or fell below the sell line. Magenta price bars show MACD crossover points.

Tracking Trend Cycles with Moving Averages

Many analysts use two exponential moving averages together to identify trends.4 Ideally the longer EMA mirrors a currency’s trend, and the shorter average follows the intermediate or minor retracements within the trend.

Trend action in the Australian dollar chart shown below is tracked using EMA lines. When the faster yellow EMA line is above the slower green EMA line, and both are rising, an uptrend is taking place.

Schaff Trend Cycle Inputs

The Schaff Trend Cycle indicator improves on the performance of the MACD by using three inputs:
  1. TC Period: Set at half the estimated time cycle length.
  2. MA1 Period: Shorter-term Exponential Moving Average.
  3. MA2 Period: Longer-term Exponential Moving Average.

Chart 3 AUD/USD 1 Hour Chart: 5/16/02 – 5/20/02
This chart shows 23-period and 50-period EMA lines (yellow and green, respectively).
The default inputs are set at 23 and 50 for the EMA lengths. But traders can choose their own MA period inputs, based on the moving averages that they prefer to follow. The Schaff Trend Cycle works well with the default inputs in most timeframes. But I also vary them. I sometimes use smaller EMA length inputs for longer timeframes. With weekly charts I might try 12 and 26, or 7 and 13. For shorter-term charts, I tend to increase the EMA lengths. For example, on a 10-minute Aussie Dollar chart, for instance, I will often use 115 and 240 for EMA lengths.

The “TC Period” uses half the estimated length of a currency’s standard time cycle. Most currencies exhibit a 17-22 period recurring cycle. The default TC length is therefore 10, or about half the length of a time cycle that regularly occurs in most currencies and timeframes. Traders can vary this input to study shorter or longer cycles, or to speed up or slow down the STC indicator. A shorter TC Period, such as 5, will produce more oscillator turns. A longer TC Period will produce fewer, but perhaps more accurate turns.

Finding Trend Cycle Lows in an Uptrend

The movement of trend cycles is often mirrored in currency prices. In an uptrend, when the Schaff Trend Cycle Indicator is rising, prices tend to stabilize or follow the cycle higher. Similarly in a downtrend, when the STC is falling, prices follow the cycle down. Between May 17th and May 20, 2000, Aussie prices were sharply rising (see Chart 3). The ideal time to buy into this uptrend would have been after a trend cycle had bottomed out, after a pause or retracement in the uptrend had ended. That can be hard to determine or see, though, using EMA lines alone (see Chart 3). But look what happens when we add the Schaff Trend Cycle indicator (see Chart 4).
The yellow STC oscillator highlights trend cycle bottoms and tops.

The first Trend Cycle Low occurs where the Schaff Trend Cycle indicator (STC) turns up from below the 25-line. The trend cycle continues to rise until the STC turns down from above the 75-line. From there, the trend cycle declines to the second Trend Cycle Low.

Notice how the Aussie prices move sideways as the trend cycle moves from the Trend Cycle High to the second Trend Cycle Low. This is consistent with what typically occurs during a consolidation within an uptrend. The market pauses, and then, takes off again, near the second Trend Cycle Low, along with the beginning of a new trend cycle.

If the place to buy into an uptrend is after a trend cycle has bottomed, then we need to clearly see the price bar associated with the STC turn. To find this entry point we can add the Schaff TC Trigger to the price chart.
Chart 4 AUD/USD 1 Hour Chart: 5/16/02 – 5/20/02
The yellow Schaff Trend Cycle Indicator is shown in the lower chart panel.

Using the Schaff TC Trigger

The Schaff TC Trigger provides a setup and trigger approach to create automated trade entry and exit signals, based on the Schaff Trend Cycle Indicator (STC).

In the chart above, buy signals are constructed in a three-step process.
  1. The yellow Schaff Trend Cycle indicator drops below a buy line.
  2. The STC turns up. The price bar above it is colored green and is called a setup bar.
  3. A high of the setup bar is exceeded or "triggered"5 initiates a long position.
5 Traders can employ various trigger rules. For shorter intraday timeframes I require that a market close above a buy setup bar in order to consider it “triggered”. For a sell setup bar, I require that a market close below it to consider it “triggered”. Another variation is to require that the market trade a certain number of points above a buy setup (or below a sell setup bar) in order to consider the setup bar triggered.
Chart 5 AUD/USD 1 Hour Chart: 5/16/02 – 5/20/02
The green and magenta Schaff TC Trigger bars show potential buy and sell points within an uptrend.

               

© 1996-2011 ForexBarometer