Aligning short and long-term indicators

Relying on a completely systematic approach to trading helps you avoid the pitfalls experienced by many discretionary traders. Every entry and exit is precisely defined, back-tested, and statistically analyzed for current market conditions, removing all emotions from trading.

The highly liquid Forex markets have shown themselves to be the most suitable for such trading algorithm implementation. The systems we use are based on Digital Signal Processing and are highly complex. A full explanation of all the potential trade set ups and exits could fill an entire book but here is one strategy based on our methodology.

We prefer to look at four-hour charts (see four-chart of the EUR/USD below) so as to smooth the movements and trade the trends rather than the price action, but this technique could be used on many different time scales. Added to the chart are some simple indicators commonly used by traders. There are two simple moving averages 100- and 200-period; stochastic, 6,2,2, and a parabolic SAR, .035 and .2.

In this particular set up we are looking for short term moves to align with the longer-term market momentum. Market momentum is measured by the moving averages. In this example the fast moving average is below the slow moving average and the distance between the two moving averages is increasing, an indication of a bearish trend that is increasing in momentum.

With the direction of the trade established, the system will look to find the optimal entry point. In this set up the entry is based off the stochastic confirming price action that is aligning with the long term trend and momentum. The stochastic is constantly changing as a bar is being formed, so we wait until the close of the bar to enter this set up. In all three trades in this example the stochastic follows price movement against the trend and the actual entry is made as the stochastic’s bear indicator (red) is above the bull indicator (blue) and decreasing in value. Once in the position a protective stop is placed at the high of the recently closed bar (represented by the x in the example).

Once in a position we have numerous exit strategies running at all times. In this example the parabolic SAR is used to exit the position. This exit strategy is ideal for strong trending markets. While in a position the SAR is also a strong indicator of a profitable trade. When in a short position if the SAR is above the market price within two bars from the entry (or below the market price for a long entry) than the trade has a much greater success rate. Often times tighter money management rules are applied when the SAR does not confirm a strong position within two bars. When markets are choppier profit targets can be employed, and calculated at a multiple 1.5X or 2X that of the pips at risk when the trade is entered.

Like all trend trading set ups, it is important to keep a close eye on the risk to return management. Delta FX Blue’s program has produced a profit percentage just better than 50/50, 50.96%, but has returned 20.25% over the past last year. The reason is the risk to return management. In the above example three trades are shown from this set up. The second trade is a losing trade but the loss is cut short (35 pips), while the first and third trades are allowed to run (118, 176 pips).

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