Technical analysis as a concept is quite large and comprehensive. It consists of an extensive range of indicators, patterns, and charts that traders can use to benefit from. Among the host of technical indicators, the Schaff Trend Cycle (STC) is one of the most widely used. The Schaff indicator is very similar to the Moving Average Convergence Divergence (MACD) indicator, but with an increased level of accuracy. Let’s delve a little deeper into the Schaff Trend Cycle indicator and try to understand how it works.
What is the Schaff Trend Cycle?
Conceptualized and developed in the 1990s by a prolific forex trader named Doug Schaff, the Schaff Trend Cycle is an oscillating indicator. The STC indicator is widely used to identify trends and their directions. It is sometimes used by traders to predict trend reversals as well. Based on the movement of the Schaff Trend Cycle, buy or sell signals are generated, which are then used by traders to initiate either long or short positions.
The Schaff indicator works on the concept that trends, whether bullish or bearish, happen in a cyclical manner with repeating highs and lows. This essentially means that at the end of every trend, the market movement reverses and forms a new opposite trend. For instance, if the market is trending upward, at the end of the upward trend, the market movement would reverse and adopt a downward trend. And at the end of the downward trend, the market movement would again reverse and adopt an upward trend. This kind of a cyclical movement goes on and on.
What does the Schaff indicator look like?
If you track the white Schaff indicator line (also known as the signal line) closely, you can see that it represents the movement of the asset price above. Furthermore, you can also see that it makes repeated highs and lows, thereby confirming the fact that trends happen in a cyclical manner.
The indicator also features two other horizontal lines labeled ‘25’ and ‘75’. These two lines represent the lower and upper limits of the indicator respectively. The area shaded in white represents the time spent above or below the upper and lower limits of the indicator.
How to use the Schaff Trend Cycle indicator?
Understanding and using the Schaff Trend Cycle indicator is a very easy and effortless affair. Whenever the signal line rises above the upper limit of ‘75’ on the Schaff indicator, it signifies the entry of the asset into the ‘overbought’ territory. This generates a ‘sell’ signal since the market can correct itself and there’s a huge possibility of the trend reversing at any moment. So, when traders encounter the signal line crossing the ‘75’ mark, they can either sell the asset and exit the market, or they can initiate a short position to benefit from the trend reversal.
Similarly, whenever the signal line falls below the lower limit of ‘25’ on the Schaff indicator, it signifies the entry of the asset into the ‘oversold’ territory. This generates a ‘buy’ signal since the market can bounce back up and there’s a huge possibility of the trend reversing at any moment. Therefore, when traders encounter the signal line crossing the ‘25’ mark, they can either initiate a long position to benefit from the ensuing price rise or exit the market by covering their short positions.
When the signal line falls in between the two extremes, a trend is said to have been formed. Depending on the circumstances, the trend can either be a bullish trend or a bearish trend. Traders can also use this information of an ongoing trend to initiate positions that they think can turn favourable.
The Schaff Trend Cycle indicator is predominantly used by traders in the forex market. This is due to the fact that it works well only on high-volume and liquid markets. However, the indicator is quite versatile and can be adapted to work on highly liquid equity counters as well. That said, while the Schaff Trend Cycle can signify overbought and oversold levels, it is not capable of indicating how long an asset is likely to stay in those levels. Therefore, it is advisable to exercise caution while initiating trades based on this technical indicator.