With this strategy, the main goal is to exploit the popular saying in the trading world “the trend is your friend”. This swing trading strategy uses a combination of moving averages, support and resistance, volatility and a few other tools to maximize profits from the trends in the Forex market. At the same, the strategy aims to keep stop losses and drawdowns to a minimum.
Although this strategy can work well on all timeframes, it is best to be used on the 4h timeframe, which makes it highly suitable for swing traders.
In this strategy, the 4h chart is used as the base chart (this is where we screen for potential places on the chart where trading signals may occur) and the 1h timeframe as the signal chart, or the trade chart (where we execute orders according to this strategy).
If you choose to use a different timeframe as the base chart remember that you go one timeframe lower for the signal chart (so if 1h is the base chart then the 30m timeframe is the signal chart).
The main cornerstones of this strategy are as follows:
We need to have a trend. This strategy rests on trend behavior and without one it basically can not be used.
To determine if there is a trend or not we are going to use a set of two moving averages, out of which one is a 34 period and the other a 55 period MA. You may notice that these numbers are part of the Fibonacci sequence.
We can judge if a trend is worth trading or not by observing how the moving averages relate to price action.
Note : For this strategy feel free to experiment with different types of moving averages (like simple, exponential and weighted).
- Price action is above the two moving averages
- Price stays above the moving averages
- The 34 MA is above the 55 MA and stays above the 55 MA
- The MAs are sloping upwards for most of the time as they follow the trend
- Price action is below the two moving averages
- Price stays below the moving averages
- The 34 MA is below the 55 MA and stays below the 55 MA
- The MAs are sloping downwards for most of the time as they trail behind the trend
An example of a downtrend with the moving averages is shown on the following chart.
As can be seen from this EURAUD chart, the price tends to bounce off the two moving averages. Basically,
the moving averages are a support zone during uptrends and a resistance zone in downtrends.
It is around and inside of this moving average zone that the best trading opportunities for this trend trading strategy are to be found.
We are trying to profit on the swings in the direction of the trend. So, for this reason, we want to join the trend on the retracements.
There needs to be a trend on the 4h with the moving averages lined up as described earlier.
We need to wait for a retracement to start and for the price to move towards the two moving averages.
Once the retracement reaches the area around and between the moving averages we switch to the 1h timeframe to look for entries.
There needs to be a retracement trendline (counter the direction of the trend) that has been touched at least 3 times (as shown in the example below). This will usually be a continuation chart pattern at the same time (on the 4h chart) like a triangle or a channel.
On the 1h chart, wait for a breakout with a close of the retracement trendline in the direction of the larger trend (on the 4h timeframe).
- Enter on the breakout once price closes past the trendline (on 1h chart).
An example of how an entry with this strategy would look like is shown below.
For this particular case, we would place the stop at 30% of the daily average true range below the entry point. On that day, the ATR was 72 pips for the AUDUSD pair, so 30% of 72 is 21.6 which means we would place the initial stop for this trade at 22 pips + the spread.
Stop loss rules are explained below.
- Place the ATR (average true range) indicator on the D1 chart.
- Set the stop loss to 30% of the daily ATR behind your entry level (which is the break of the trendline).
- Add the spread to the stop loss (for some more exotic currency pairs the spread can often be 15 or more pips which can make a big difference on the 1-hour timeframe in terms of when your stop loss will be triggered).
Take the EURUSD pair which has about 100 pips usual daily range. If you entered a trade with this strategy on EURUSD, then your stop loss would be 30% of 100 which equals 30 pips plus the spread, which is usually around 1 - 2 pips for EURUSD. So, in total the stop loss, in this case, would be 32 pips. Risk management:
After you’ve entered the trade you need to manage that stop loss and trail it in order to be able to capture the maximum profit from the trend. Here is how this strategy works:
Once the price has moved 30% of the daily ATR in profit, move the stop loss to break even.
If at any point in time during the trade a counter-trend retracement trendline starts to form on the 1-hour chart then exit the trade.
A counter-trend retracement trendline would be a trendline that is touched 3 times. Once this happens there is a higher probability that a new retracement or even a reversal has started. Hence it’s better to exit the trade and wait for a new opportunity.
Because this is a trend trading strategy we will use a trailing stop for exiting the trade. This allows us to profit on a bigger part of the move.
There are some specific rules for this trailing stop order:
In an uptrend:
As the price makes new higher highs, find the most recent highest high.
Take the candle of that highest high.
Find the low of this candle.
Count backwards for 5 previous lows from the low of that candle.
Note: Only lower lows count. Lows that are the same as or higher than the previous lows are to be omitted.
- Place the stop a few pips lower than the low of the fifth candle.
In a downtrend:
As the price makes new lower lows, find the most recent lowest low.
Take the candle of that lowest low.
Find the high of this candle.
Count backwards for 5 previous highs from the high of that candle.
Note: Only higher highs count. Highs that are the same as or lower than the previous highs are to be omitted.
- Place the stop a few pips higher than the high of the fifth candle.
Here’s how this trailing stop looks on a chart.
The blue arrows are the starting point of the count and the line is the stop loss placement for that point in time. The numbers are an example of how to count the candles to determine the stop. You can see here how lower highs are left out until the next higher high backwards is found.
As the downtrend progresses with each new lower low, the counting for the trailing stop should re-done again and the stop moved lower.
Finally, go on and practice this strategy on a demo account first so you can fully grasp everything before going live. If you find it helpful some backtesting on past price data is a good way to learn and master this trend following strategy as well.