Momentum Trading Strategy in 4 hours charts

 

This trading strategy is based on the famous moving averages tunnels strategy developed by Vegas. In this particular case it was developed for 4 hour charts on any trading instruments, but is used more regularly to trade currency pairs in the Forex market. Like other similar systems, the operation is quite simple as will be seen below:

Methodology of the trading system based on momentum and tunnels for 4 hour charts

1.) To start we create a weekly chart on the asset that we are analyzing, which can be a candlestick of bar chart. This chart should contain an exponential moving average of 21 periods (EMA 21) applied precisely to the average price [(H + L) / 2], and a simple moving average of 5 periods (SMA 5) also applied to the average price [ (H + L) / 2].
Weekly price chart of USD/JPY. MT4 platform of XM broker

If we look at the chart above, we can see that as the asset price rises, logically the SMA 5 rises faster than the EMA 21 because its period is shorter. Likewise, when the price starts to fall the SMA come down faster than the EMA 21. Thus, the difference in pips between the two moving averages determines the relative momentum on the market in real time and at any given time.

In each week, if the moving averages are rising while the difference between the two moving averages still increase over the previous week, we can say that the market is in an uptrend. However, if in a week the difference in pips between the SMA 5 and EMA 21 decreases with respect to the previous week, is a clear signal that the trend is losing steam and that the price has reached a possible medium term top in which the market can bounce back and start falling.

Conversely, if in a downtrend the difference between the EMA 21 and SMA 5 is reduced relative to the previous week, it can be a clear signal that this trend is losing steam in the medium term and could reverse.

2.) Once we have identified the market momentum, the next step is to open a 4-hour chart in the same instrument that we are analyzing. It may be a candlestick or bar chart, no major difference in this point. In this chart we put a SMA of 55 periods applied to the average price [(H + L)/2] and SMA of 8 periods applied to the closing price.

H4 price chart of USD/JPY

 

If we look at the chart above, we can see the difference between two moving averages. Now that we are using moving averages of different types with very different time periods, the crossings between the two lines are quite common. This is known as momentum tunnels. Once we configured the 4 hour chart we review the weekly chart to check the momentum. If we look at the first graph we can determine that the market is in a clear downtrend. Therefore, it is best to try to open short positions and avoid buying positions as they are operating with low probability of getting good profits and always try to play it safe.

Once the 4-hour chart is configured we review the weekly chart to check the momentum. If we look at the first chart we can determine that the market is in a clear downtrend. Therefore, it is best to try to open short positions and avoid the long positions as these are trades with low probability of getting good profits for the moment. Remember that a trader should always try to play it safe.

3.) (Position opening) Then we wait until the SMA 8 moves down and cross the SMA 55 from above. In this case, we can see how the slope of the SMA 8 passes from positive to negative, indicating a clear shift in the direction of the trend on the 4-hour chart. Precisely on the 4-hour candlestick in which we see the turnaround (the candlestick where the market loses value with respect to the previous candlestick) is where we will open our positions for which we sell 3 units whose size depends on the volume of our own trading account and money management strategy. We can also open one position divided into 3 portions if that is permitted by our Forex broker.

Whatever the size of your account, just adjust the size of the units and not the number of them. Regarding the Stop Loss, one option is to use Fibonacci levels, or technical formations as resistances, supports and trend lines regarding the most recent 4 hour candlesticks.

Assuming that the price starts to drop now that the position is open, it remains on the market until any of the following conditions:

  • The SMA 8 changes its slope, in the case of this example from negative to positive (change of trend), at which time we proceed to close all our positions.
  • The price continues to fall and reaches the Fibonacci numbers corresponding to 144 pips or 233 pips as measured from the SMA 55 line. When this occurs we take part of the profits by closing the first position (the first part) in one of these levels. The other two units of the trade remain open until the price reaches the following Fibonacci numbers corresponding to 233 pips or 377 pips, while a significant change in the slope of the SMA 8 is not observed. If the price reaches one of these numbers take profits closing the second unit of the trade. The third and last portion can be left open up to the next Fibonacci number or can be closed to secure profits.
With regard to buy trade, it is the reverse process as described above. If the weekly chart indicates an uptrend, the trader should try only to open long position. In this case we should wait until the SMA 8 line crosses above the SMA 55 line in the 4-hour chart. When this occurs the slope of the SMA 8 changes from negative to positive indicating a turnaround in which the price returns to the general market direction (the weekly momentum). Precisely in the candlestick in which the asset price increases with respect to the previous one is the candlestick in which we open a new long positions with 3 units. Again the stop loss for the three units depends on the technical analysis of the most recent 4 hours candlesticks. If the price starts to rise once the position is open, we remain on the market until the following occurs:
  • The SMA 8 changes its slope, in the case of this example from positive to negative (change of trend), at which time we proceed to close all our positions.
  • The price continues to rise and reaches the Fibonacci numbers corresponding to 144 pips or 233 pips as measured from the SMA 55 line. When this occurs we take part of the profits by closing the first position (the first part) in one of these levels. The other two units of the trade remain open until the price reaches the following Fibonacci numbers corresponding to 233 pips or 377 pips, while a significant change in the slope of the SMA 8 is not observed. If the price reaches one of these numbers take profits closing the second unit of the trade. The third and last portion can be left open up to the next Fibonacci number or can be closed to secure profits.
In those cases, where the slope change and the SMA 8 line is not above or below the SMA 55 line we will use only one unit and a half to start our trade. Once we are in the market, the same rules apply previously announced.

System filters

To implement this system with a higher security level, we must apply two filters:
  1. The first of these filters is on the weekly chart. In this case if the difference between the EMA 21 and SMA 5 is equal to or greater than 500 pips, the difference in pips compared to the previous week must change by at least 10 pips or at least go down for a period of two consecutive weeks to indicate a possible change in trend.
  2. The second filter is shown on the 4-hour chart. In this caset if the asset price, the SMA 8 and SMA 55 are within a range of about 50 pips from each other, we can use a breakout criterion to start a trade. We do this to avoid the false signals that in these circumstances can produce the SMA 8 when it jumps few pips in each set of candles, which can induce the trader to enter the market and open positions with little chance of success. Under these conditions, a breakout may be the best signal to enter the market especially if it occurs in the general direction of the weekly trend we have determined in the first chart.
It is worth noting that the use of a SMA of 8 periods applied to the closing price allows to determine more accurately the time to enter the market, just in the moment when a candlestick in the 4-hour chart clearly shows that the market is not following the trend. In this case, this can be viewed more easily in the candlestick in which the SMA 8 begins to change its slope.

 

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