Schaff Trend Cycle (STC) Indicator - Strategy and Trading Rules

There are several trading tools and indicators available to us day traders but only a few can track market movements and price action like the Schaff Trend Cycle (STC) does. What do you know about this indicator?

The Schaff Trend Cycle (STC) is a momentum oscillator that uses stochastic methods to improve the ever-popular MACD indicator. It is a modified MACD indicator that uses cyclical methods to filter out market noise and identify short-term trend cycles. The indicator oscillates between 0 and 100 and its signals include overbought/oversold conditions, signal line crossovers, and divergences.

In this post, we will take a look at most of the questions you may have about this indicator: what it is, how it works, and how you can improve your trading strategies with it. Let’s dive in!

Table of contents:

Key takeaways

Schaff Trend Cycle (STC) is a momentum oscillator that uses stochastic methods to improve the ever-popular MACD indicator.
The indicator oscillates between 0 and 100 and its signals include overbought/oversold conditions, signal line crossovers, and divergences.
We provide you with a backtested Schaff Trend Cycle trading strategy.
This post is just one of the many trading indicators we have written about.

What is the Schaff Trend Cycle?

Introduced in the 1990s by Doug Schaff, the Schaff Trend Cycle (STC) is a momentum oscillator that uses stochastic methods to improve the ever-popular MACD indicator. It is a modified MACD indicator that uses cyclical methods to filter out market noise and identify short-term trend cycles.

It does this by calculating the difference between two separate exponential moving averages (EMAs) of the price and using a 10-period stochastic to add a periodic cycle component to identify when a trend cycle may be ending before a reversal.

The indicator oscillates between 0 and 100 and its signals include overbought/oversold conditions, signal line crossovers, and divergences. Traders use the indicator to identify short-term swings and may combine it with other analysis tools for better results.

For an example of how it might look on a chart, please look here:

The lower pane shows the STC indicator.

Schaff Trend Cycle (STC) Indicator trading strategy – trading rules, returns, and performance

Before we continue, we go straight at a backtested trading strategy where we use the Schaff indicator.

We make the following trading rules:

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(The trading rules are better explained in the code below.)

These trading rules return the following equity curve for GOOG from 2015 until today:

For individual stocks, there are not that many trades.

If we apply the same rules on Nasdaq 100 (QQQ) we get the following curve:

Since its inception, the strategy has had 199 trades, and the average gain is a solid 1.25% per trade. The win rate is 75%, and the max drawdown is 26%. The worst year was 2022, when the strategy witnessed a 2.7% loss.

Schaff Trend Cycle code for the backtest

For your convenience, we provide you with the full code for the strategy (Amibroker):

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CLICK HERE TO SEE ALL 400 ARTICLES WITH BACKTESTS & TRADING RULES

How is the STC indicator calculated?

To calculate the STC indicator, follow these steps:

Step 1: Calculate the 23-period and the 50-period EMA and the MACD values as follows:

EMA1 = EMA (Close, 23-period)

EMA2 = EMA (Close, 50-period)

MACD = EMA1 – EMA2

Step 2: Calculate the 10-period Stochastic from the MACD values as follows:

%K (MACD) = %K Value (MACD, 10)

%D (MACD) = %D Value (MACD, 10)

Step 3: Calculate the STC indicator

STC indicator = 100 x (MACD – %K (MACD)) / (%D (MACD) – %K (MACD))

What does the STC indicate in trading?

In trading, the STC indicates the direction of an emerging short-term trend cycle and potentially identifies the highs and lows of the cycle as overbought and oversold conditions. If the STC indicator is falling, it means that the short-term trend cycle is bearish and the price is making a downward swing. When the indicator falls below the 25 level, the market is considered oversold and could soon reverse.

On the other hand, if the STC values are increasing, it means that the short-term trend cycle is bullish and the price is making an upward swing. When the value is above the 75 level, the market is considered oversold and could reverse.

Why do traders use the Schaff Trend Cycle?

Traders use the Schaff trend Cycle because it filters out market noise to show more reliable short-term market swings. The indicator helps traders identify trend cycles, as well as potential market reversals. It can also be used to generate buy and sell signals, especially when combined with other analysis tools that show the direction of the main trend.

If the main trend is up and the STC is emerging from the oversold region, rising above the 25 level, a buy signal is generated. Likewise, if the main trend is down and the STC is emerging from the oversold region, falling below the 75 level, a sell signal is generated.

How does STC compare to MACD?

The STC can be compared with the MACD, as both are created from similar concepts. Here’s how the STC compares to MACD:

Calculation: Both use two EMAs and find the difference between the two EMAs. But while the MACD uses 13 and 26 periods, the STC uses 23 and 50 periods. Also, the MACD indicator stops finding the difference between its two EMA and getting a 9-period EMA of it, but the STC uses a 10-period stochastic method to add a period cycle to the indicator.
Oscillation range: The MACD oscillates above and below zero, with no upper or lower range limit, while the STC oscillates between 0 and 100.
Overbought/oversold levels: The STC has specified overbought/oversold levels at 75/25 levels, but the MACD does not have a specified level.
Signals: The STC offers less false signals than the MACD.

Can STC predict market trends?

Yes, the STC can predict market trends, especially short-term market trends. It does this by combining MACD and stochastic techniques to offer a unique perspective on the direction and momentum of the short-term trend.

But more interesting to swing traders is the fact that it can show the emergence of new swings when it rises from the oversold region or falls from the overbought region — the former signaling a bullish swing, and the latter signaling a bearish swing.

What are the best settings for STC?

The best settings for the STC would depend on your trading strategy, the market you’re trading, and the findings from your backtesting. The market you are trading and the conditions of the market should determine the strategy you use — for instance, whether to trade for trend a continuation or a trend reversal.

But how you know the best setting for whichever strategy is by backtesting the strategies with different settings of the indicator to know the setting that works best.

How does STC identify buy signals?

The STC indicator identifies buy signals by showing when an existing short-term downtrend is exhausted and a new bullish trend emerging. This works best in a setting of a long-term uptrend. It is best to combine the indicator with another indicator or tool that shows the direction of a long-term trend. In a long-term uptrend, when the STC indicator emerges from the oversold region, rising above the 25 level, a buy signal is generated.

How does STC identify sell signals?

The STC indicator identifies sell signals in a setting of a long-term downtrend. In such a scenario, it shows when an existing short-term uptrend (market rally) is exhausted and a new bearish swing is emerging.

To get the best sell signals, combine the indicator with another indicator or tool that shows the direction of a long-term trend. If the market is in a long-term downtrend, a sell signal is generated when the STC indicator emerges from the overbought region, falling below the 75 level.

What time frames work best with STC?

The time frames that work best with the STC indicator would depend on your trading style, the market you’re trading, and your backtesting results. If you are a day trader, you may want to focus on the hourly, 30-minute, and 15-minute time frames.

A swing trader, on the other hand, may want to focus on the 4-hourly and daily time frames, while a position trader may even go to higher time frames. However, you will only know the time frames that work best for whatever trading style you’re using from the results of your backtesting.

Can STC be used for all trading markets?

Yes, the STC can be used for all trading markets since it uses only the price data in its calculation. So, as long as the historical price data is available for a market, the STC indicator can be used in that market.

This is unlike indicators that use volume data in their calculations, which cannot be used in markets without reliable volume data, such as the spot forex market.

What are the limitations of the STC indicator?

The limitations of the STC indicator include the following:

The indicator is prone to a whipsaw effect when the market condition is choppy.
It performs poorly in range-bound markets, as it struggles when there is no clear trend.
The indicator cannot be used as a standalone tool, as it cannot show the long-term trend.
It can be subject to changing market volatility.

How to add STC to a trading chart?

To add the STC indicator to a trading chart, you will first check whether the trading platform you’re using has a built-in STC indicator. If it doesn’t, you will have to get a custom-made indicator and install it on the trading platform.

After you’ve done that, you can go to the indicator section of the platform and double-click on the STC indicator or simply grab it and place it on the chart. It will bring up the settings box for you to select the settings you want and then click OK.

What does a rising STC line mean?

A rising STC line means an increasing momentum in the upward direction. However, whether this is an indication to go long in the market would depend on many other factors, including the direction of the main trend, the prevailing market condition, and where the STC line was when it started rising.

If the main trend is up, the market condition isn’t choppy, and the STC line is rising from the oversold region to above the 25 level, it could be a signal to go long and ride the next wave of upward price momentum.

What does a falling STC line mean?

A falling STC line means an increasing momentum in the downward direction. But whether this is an indication to go short in the market would depend on the direction of the main trend, the prevailing market condition, and where the STC line is falling from.

If the main trend is downward, the market condition isn’t choppy, and the STC line is falling from the overbought region to below the 75 level, it could be a signal to go short and ride the next wave of downward price momentum.

How can STC be combined with other indicators?

To combine the STC with other indicators, you first have to understand how the indicator works so you can combine it with other indicators that complement it.

The indicator works best in showing the direction and momentum of short-term trend cycles, so it has to be used with indicators that show the long-term trend. When you have such a combination, you can create a trend-following strategy that aims to ride the next impulse wave in the trend direction.

What are common mistakes when using STC?

The common mistakes when using the STC indicator include:

using it as a standalone strategy, which is prone to many false signals
not identifying the main trend and trading only in that direction
ignoring market conditions, which can create poor signals
not having a risk management plan.

How to interpret STC crossovers?

To interpret STC crossovers, you have to check the direction of the main trend and the direction of the STC crossover. If the main trend is up, and the STC crosses above the 50 level from below, it means there is a bullish crossover.

On the other hand, if the main trend is downward, a bearish crossover occurs when the indicator line crosses below the 50 level from above. If the direction of the main trend doesn’t match the direction of the crossover, it is market noise.

What is the significance of the STC’s period setting?

The significance of the STC’s period setting is that it affects the smoothness of the indicator and how well it filters out false signals. When the period setting is short, the indicator will be less smooth and will have a lot of false signals.

But when the period setting is long, the indicator will be smoother and will give fewer false signals.

How does STC perform in volatile markets?

The STC indicator does not perform so well in volatile markets, as such markets do not show clear trends. The indicator needs a clear trend to generate quality signals. When the market is volatile, the price swings about without a clear direction. In such a situation, the STC will give many false signals, diminishing its performance.

How do traders adjust STC for different market conditions?

To adjust the STC indicator for different market conditions, traders must have a way to identify different market conditions. They may have to use an indicator that predicts the market condition.

For instance, an indicator that identifies the long-term trend can show when the market is trending so that traders can use the STC indicator to find opportunities in that direction. When the trend is not clear, they can adjust the STC indicator to reduce the likelihood of false signals.

What are examples of successful trades using STC?

Here are examples of successful trades using STC:

Example 1: US100 buy signal

In the chart below, you can see the price was in an uptrend, as indicated by the rising uptrend line (white line). During a pullback, the indicator fell into the oversold region. When it rose above the 25 level a buy signal was generated, marking the emergence of the next bullish impulse swing.

Example 2: US100 sell signal

In the chart below, you can see the price was in a downtrend, as indicated by the descending downtrend line (white line). During a pullback, the price rallied to the trendline, and the indicator rose to the overbought region. When it fell below the 75 level a sell signal was generated, marking the emergence of the next bearish impulse swing.

How to use STC for short-term trading?

To use the STC for short-term trading, you have to combine it with other analysis tools or indicators that can show the long-term trend so you can focus your short-term trading in that direction.

For instance, when the main trend is up, you can look to go long when the STC rises above the 25 level from the oversold region. When the long-term trend is downward, you look to enter a short position when the STC falls below the 75 level from the overbought region.

How to use STC for long-term trading?

To use the STC for long-term trading, you have to use a high timeframe such that the short-term trends on the timeframe would be equivalent to long-term trading.

The reason is that the STC indicator shows the direction and momentum of short-term trends. It is not equipped to indicate long-term trends. So, if you must use it for long-term trading, use it on high timeframes.

What are STC’s false signals and how to avoid them?

STC’s false signals are signals generated by the STC indicator that are not in the direction of the main trend. This often happens when the market is choppy and the trend is not clear. It can also happen in a ranging market.

Thus, to avoid them, you have to identify choppy and ranging markets and avoid trading with the STC indicator in such market conditions — limit your STC trading to only clearly trending markets.

How to improve trading accuracy with STC?

To improve trading accuracy with STC, you have to combine the indicator with other analysis tools and indicators that show the direction of the long-term trends.

With that, you limit your trading to the direction of the long-term trend only and trade only when the trend is clear. This way, you can reduce the chances of false STC signals and improve your trading accuracy.

Can STC be automated in trading systems?

Yes, the STC can be automated in trading systems by creating a robust strategy with the indicator alongside other indicators and then converting the strategy to a trading algorithm. The trading algorithm even makes it easier to backtest and optimize the strategy and periodically evaluate the results.

What historical data is best for testing STC?

The best historical data for testing an STC strategy is one that covers different market phases and conditions, such as uptrends, downtrends, sideways markets, and choppy market conditions.

Also, the historical data must be divided into in-sample and out-of-sample data — the former for testing and the latter for evaluation and optimization.

How do market trends affect STC’s effectiveness?

Market trends affect STC’s effectiveness by showing the direction with the most likely valid signals. The STC indicator works best in clearly trending markets and generates its best signals in the direction of the trend.

So, focusing only on signals in the trend direction increases STC’s effectiveness, while using signals in the opposite direction or signals generated in non-trending markets reduces STC’s effectiveness.

How to practice trading with STC in a demo account?

To practice trading with STC in a demo account, you have to register with a broker that offers a demo account to access such an account. Then, you install the STC on the trading platform and formulate an STC-based strategy.

Next, backtest the strategy to know the settings that work best and the right risk parameters to use. With these, you can trade on your demo account to see how well you can implement the strategy.