We have investigated the possibility of producing a magnetic encoder by an innovative process. Instead of turning grooves in the encoder bar for precise positioning, we incorporated the information in 304L stainless steel by transforming the austenite to martensite after bar extrusion in liquid nitrogen and marking it with a laser, which caused a local transformation of martensite back into austenite. 304L has an excellent corrosion resistance, but a low hardness and poor wear resistance, which limits its range of applications. However, nitriding is a very promising way to enhance the mechanical and magnetic properties. After low-temperature nitriding at 400 °C it is clear that both ε- and α'-martensite are present in the deformed microstructure, indicating the simultaneous stress-induced and strain-induced transformations of the austenite. The effects of a laser surface treatment and the consequent appearance of a non-magnetic phase due to the α' → γ transformation were investigated. The EDS maps show a high concentration of nitrogen in the alternating hard surface layers of γN and α'N (expanded austenite and martensite), but no significantly higher concentration of chromium or iron was detected. The high surface hardness of this nitride layer will lead to steels and encoders with better wear and corrosion resistance.