The strategy combines a customized MACD indicator with two exponential moving averages (EMAs). This strategy therefore combines a momentum indicator with a trend indicator.
The moving averages will be used as support-resistance indicators while the MACD will be used to detect the trend change as well as momentum for the trade. Apply the strategy in one of the upcoming contests.
The indicators used are as follows:
- Customized colour-coded MACD histogram: This is a MACD histogram which has been manually adjusted to include a color code which changes as the trend in the market changes. This deals with a fundamental problem of the regular MACD indicator, which tends not to pick up trend changes early. For this strategy, color-coding and early trend change detection is important so that a lot of profits are not left on the table.
- The 50-day Exponential Moving Average (50 EMA), with its default settings deployed. For the purpose of our demonstration, we have set the color of this indicator to yellow.
- The 110-day Exponential Moving Average (110 EMA), used with its default settings. The indicator is set to a red color for our illustration.
The basis of the trade is to use the moving averages as the support-resistance for the trade, and use the price bounce off these moving averages along with a color-change in the MACD histogram to define the new trend of the asset and therefore the trade opportunity.
The following signals indicate that a trader should enter a long trade:
- The 50 EMA should be above the 110 EMA and the cross must have happened recently from the chart picture.
- The colour of the MACD histogram must have changed from red to blue, giving us a bullish bias.
- Price action is bouncing off the 50 EMA at the same time that (a) and (b) above have occurred.
The setup is demonstrated in the example below:
Looking at this chart above, there are several areas where a long trade could be setup based on the entry parameters for this strategy.
With the 50 EMA positioned above the 110 EMA, the bias for the trade is definitely bullish. The next stage is to look for an area where the MACD is blue in color.
The first point is perfect. Not only is MACD just turning blue, but the MACD histogram bars are just taking off from the zero level at the same time price is bouncing off the 50 EMA (yellow).
For this trade, the TP is not fixed when the trade commences. Rather, the trader should watch the moving averages and MACD indicator to see when they have started to turn downwards.
This is a signal that trade is reversing and the trade can then be either closed manually, or a trailing stop set in case the trade takes off in the uptrend once again. Two other areas for possible long trades are identified in the curve.
The trade was taken on the 4 hour chart of the GBPUSD, providing ample opportunity for profit. Each trade would have been worth at least 300 pips.
For the short trade, these are the parameters we would be looking for:
- The 50 EMA should be below the 110 EMA and the cross must have happened recently from the chart picture.
- The color of the MACD histogram must have changed from blue to red, giving us a bearish bias.
- Price action is resisted at the 50 EMA at the same time that (a) and (b) above have occurred.
The chart brings up two interesting scenarios. First, we see two areas where there would have been valid entry points for a short trade.
Price action is resisted at the 50EMA when the MACD histogram was red in color. The area marked TP is the appropriate place to exit the trade, as the MACD bars are heavily in negative territory and therefore ripe for reversal, and the bars started to turn blue.
We also see an area where the price was resisted at the 50EMA, but the MACD bars were blue. This is an invalid entry because the entry parameters did not conform to our rules.
Stop Loss settings: For both trade setups, the Stop Loss is set either some pips below the 110 EMA (long trade) or some pips above the 110 EMA (short trade).
The 110 EMA for this trade will serve as a support-resistance that is even more powerful than the 50 EMA. If price moves negatively towards the 110EMA after trade entry and breaks it, then the trade will fail and your stop loss would be triggered, protecting your trade against huge losses.
The strategy will work best on the 4 hour chart, with typical price moves of between 200 and 400 pips. The strategy is best used on currency pairs that can trend. Typical trades should last for a week.