Last Updated on February 6, 2023
There are many patterns that occur in the financial markets, and smart traders who can identify them use them to their advantage. This is the case with the stairs, which are commonly seen patterns on price charts. But what is the stairs trading strategy?
The Stairs Trading strategy is a technical analysis method that is used to identify key levels of support and resistance in the market. The strategy is based on the idea that prices tend to move in a stair-like fashion, with each step representing a key level of support or resistance. By identifying these levels, you can make informed decisions on when to enter or exit a trade.
In this post, we answer some questions about the stairs trading strategy, and we provide a backtest.
Introduction to Stairs Trading Strategy
In a trending market, even the short-term trends, the price moves in swings, with big swings in the trend direction and temporary pullbacks or consolidations that can look like the stairs of a building.
Given this pattern of price movement, traders try to use this stairs pattern to incrementally add to their positions at every consolidation step. In other words, it’s often used as a filter to add to positions.
What is Stairs Trading Strategy?
The Stairs Trading strategy is a technical analysis method that is used to identify key levels of support and resistance in the market. It involves looking for patterns in price movements, such as breaks through support or resistance levels, and using that information to make informed trading decisions.
The strategy is based on the idea that prices tend to move in a stair-like fashion, with each step representing a key level of support or resistance. By identifying these levels, traders can make informed decisions on when to enter or exit a trade.
As far as we can see, the system is a little bit like Nicolas Darvas’ box system:
Benefits of Stairs Trading Strategy
There are several benefits of using a Stairs Trading strategy, which include:
- Identifying key levels of support and resistance: By identifying these levels, traders can make informed decisions on when to enter or exit a trade and limit their risk by setting stop-loss orders at key levels.
- Analyzing patterns in price movements: By looking for patterns in price movements, traders can gain insight into market trends and anticipate potential changes in direction.
- Adaptability: Stairs Trading strategy can be used in multiple markets and for different trading instruments, it is a flexible technique.
- Managing risks: The strategy can help to reduce risk by spreading out trades across every step and capturing small gains along the way, rather than taking on large amounts of risk at once.
If you are a quant, like we are, you have probably identified the problem with the stairs trading strategy: it’s a strategy that is very difficult to put into trading rules to get it backtested. It’s too much judgement involved.
Analyzing the Markets with Stairs Trading
Analyzing the markets with Stairs trading involves identifying price consolidations or pullbacks at key levels of support and resistance in a trending market.
You can use previous swing highs and lows to identify key support and resistance levels. You should look for patterns in the price movements, such as breaks through support or resistance levels, and use that information to make informed trading decisions.
Key Components of Stairs Trading Strategy
The key components of the Stairs Trading strategy include
- Identifying key levels of support and resistance
- Waiting for price consolidation or pullbacks
- Analyzing patterns in price movements
- Monitoring economic indicators and news events
- Using all this information to make informed trading decisions
Risk Management with Stairs Trading
Risk management is an important aspect of stairs trading strategy.
To manage risk effectively, traders should set stop-loss orders at key levels of support and resistance, and limit the amount of capital they risk in any given trade to just a small account of their account balance.
Another way to manage risk is diversifying portfolios across different markets and timeframes. It is also necessary to review results regularly and adjust the strategy’s parameters. The latter we have covered in many articles:
- What does correlation mean in trading? (Trading strategies and correlations)
- Uncorrelated assets and strategies – benefits and advantages
- Does your trading strategy complement your portfolio of strategies?
- Why build a portfolio of quantified strategies
Implementing Stairs Trading Strategy
To implement the Stairs Trading strategy, you should first identify the trend and key levels of support and resistance on a chart. Then, you look for consolidation patterns in price movements around levels of support and resistance.
Once you have identified a potential trade, you should set a stop-loss order at a key level of support or resistance, and determine the appropriate position size based on your risk management plan.
What are the Advantages of Stairs Trading?
The advantages of Stairs Trading are, given that you are good at making good judgment calls:
- Ability to spot key levels of support and resistance
- Easy to analyze patterns in price movements
- Ability to ride the trend step by step (wave by wave)
- Adaptability to different markets and instruments
- Effective risk management
- Regular review and adjustment for performance improvement
Again, we emphasize that this strategy relies upon chart patterns that are hard to quantify. This applies to risk management techniques as well. If you have not backtested the strategy, how do you know if you’ll make money on the strategy?
The fact is that you don’t know until you have backtested it.
How Can I Maximize Profits with Stairs Trading?
To maximize profits with Stairs Trading, you should master the strategy very well and be disciplined enough to execute it well.
You should know how to identify the trend, key levels of support and resistance, and price consolidations. You must have precise entry and exit criteria and make use of risk management techniques to limit risks.
What Are the Key Features of Stairs Trading?
The key features of Stairs Trading include:
- identifying the trend
- identifying key levels of support and resistance
- analyzing patterns in price movements
- effective risk management
- regular review and adjustment for performance improvement
What Are the Risks Involved with Stairs Trading?
Some of the risks involved with this strategy include the following:
- Inaccurate analysis: Incorrectly identifying key levels of support and resistance or failing to keep an eye on important economic indicators and news events can lead to poor trading decisions
- Overtrading: This can lead to poor trading decisions and losses. Sometimes the best trades are the ones you DON’T take. Avoid unforced errors.
- Emotional trading: Letting emotions guide your trading decisions can lead to impulsive and irrational moves, which can result in significant losses.
How Do I Implement Stairs Trading in My Investment Portfolio?
To implement Stairs Trading in your investment portfolio, you can follow these steps:
- Identify the markets or trading instruments you wish to trade
- Analyze charts to identify key levels of support and resistance
- Look for patterns in price movements such as breaks through support or resistance levels
- Execute your trade in those markets, allocating the right amount of capital to each market
- Regularly review your trades and make any necessary adjustments to improve your performance.
Are There Other Strategies Similar to Stairs Trading?
Yes, other strategies are similar to Stairs Trading, such as:
- Trend-following strategies
- Breakout trading strategies
- Swing trading strategies in a trending market
- Fibonacci retracement-based strategies
All these strategies involve analyzing market trends and using that information to make informed trading decisions. However, you need to combine them, either in one strategy or a combination of several strategies.
How Do I Choose Stocks for Stairs Trading?
To choose stocks for Stairs Trading, you should focus on companies that have a history of consistent financial performance. For example, as a heuristic, you can use dividend-paying stocks. You are limiting yourself, but you are at least picking stocks that can make dividend payments, thus buying stocks that have mostly positive cash flows.
Use fundamental analysis to evaluate the company’s financials and also look at its management and competitive landscape. Also, look at the stock charts to be sure that it is trending upward and identify key levels of support and resistance.
What Are the Benefits of Using Automated Stairs Trading?
The benefits of using automated Stairs Trading include:
- Trading algos can quickly identify key levels of support and resistance, analyze patterns in price movements, and execute trades 24/5, as long as the markets are open.
- It can implement risk management strategies efficiently
- It is easy to backtest the trading system
- An automated system reduces the emotional and psychological impact on the trader, which can be beneficial for long-term trading
How Have Stairs Trading Evolved Over Time?
Stairs Trading has evolved over time as technology and market conditions have changed.
The use of computers and software for charting and analysis has made it much easier for traders to identify key levels of support and resistance and analyze patterns in price movements.
Stairs trading strategy backtest – does it work?
By now, you probably understand that the Stairs Trading strategy relies very much on trading rules that are hard to quantify.
Let’s backtest a 100% quantified strategy that is somewhat similar to the philosophy of the stairs system. We make the following trading rules:
- The close must be above the 200-day moving average.
- The close must be below the 25-day moving average.
- If 1 and 2 are true, then enter at the close.
- When the close crosses above the 25-day moving average, we exit at the close.
Why is this similar to a stairs system? Because we use a long-term trend filter to determine the trend, but we use a short-term pullback average for entry.
How has the strategy performed? We backtested S&P 500 (SPY) since 1993, and it returned the following equity curve:
The annual return is 6.1%, below buy and hold, which made 7.7%, but the strategy has substantially lower drawdowns, almost consistently lower than 20%, because it’s invested only 23% of the time.
The backtest is just one example of combining a long-term trend filter and short-term pullback to resemble a Stairs Trading strategy (pullback to assumed support). There are plenty of other indicators you can use for a pullback: RSI indicator, Stochastics, etc. Please have a look at our technical indicator guide.
List of trading strategies
We have written over 1000 articles on this blog since we started in 2012. Many articles contain specific trading rules that can be backtested for profitability and performance metrics.
The code for the backtested Stairs Trading strategy is included in the package.
The trading rules are compiled into a package where you can purchase all of them (recommended) or just a few of your choice. We have hundreds of trading ideas in the compilation.
The strategies are taken from our source of the best trading strategies.
The strategies also come with logic in plain English (plain English is for Python traders).
For a list of the strategies we have made, please click on the green banner:
These strategies must not be misunderstood for the premium strategies that we charge a fee for:
Can the strategy be improved?
We are not oracles, and we are pretty sure there are traders out there who can improve the strategy. Do you have any ideas on how to improve it?If so, please comment below or drop us an e-mail.