A moving averages momentum trading system—trade management and forecasting.

Introduction

Continuing our analysis of the entry triggered by what we described in detail as a system for exploring the momentum of the market, using two timeframes and a set of moving averages, plus the Bollinger bands, part one being [click] here and part two being [click] here.

Stop loss placement and justification

The stop loss order is entered immediately on entry at 5390 as per the previous article, above the 88.6% (maximum) fib retracement of the entry candle on the H1 chart (level marked in red).

Entry timing and limit order usage

The entry at market is at the close of the H1 candle, NB it would be acceptable, and indeed professional, to place either a sell stop entry 1 pip below the close of the H1 candle, likewise a sell limit entry either at the 38.2%, 50%, 61.8% or 78.6% of the H1 candle, for even less risk, though in this case (actually a rarity), such an order would not have been filled.

Initial trade progression

After the entry, there is a dead drop, all seems wonderful.

However, the market is halted for 30 minutes what looks like the 61.8% level of the prior upswing (not marked).

This is followed by lower low, forming a lower high, lower low pattern, promising for our continuation.

Doji candle

There is then a doji candle, just to the left of the ‘E’ in the word entry marked on the above chart.

Lower high progression

Notice that the three candles including the doji and the two to the left of the doji, each have slightly lower highs.

Weak directional closes defined

There are then three upward facing candles, however, each fails to close much above its 50% level – for a candle to be considered bullish, really, we would want to see it closed in the top 25% at least – again a good sign for this trade.

Mini-swing correction defined

Thus what we have is the formation of a mini-swing correction, making up a rectangle potential energy building area, tested several times to the upside, followed by a new swing lower, consisting of three bearish candles,

Three black crows Japanese candlestick pattern

NB. This is also the ‘three black [in this case red] crows’ Japanese candlestick pattern.

As per the figure above, a new M15 swing low is established 2 hours and 45 minutes after entry, as marked by the first red elipse.

Confirmation of swing correction

The swing correction is confirmed by the multiple testing near the entry level forming a region of sideways flow after the entry with a clear top as we just mentioned.

New swing establishment

The break of the low and close beneath it confirms the new swing is being established at the point of the close of the candle whose lower body and wick protrudes through the first red elipse marker

Stop management

The stop can then be brought above the correction high, effectively placed at the break even point.

Chart: 15 minute chart highlighting new swing low formation

Let us look more closely at the targets.

Fibonacci retracements and expansions

In the next chart, we have drawn Fibonacci retracements and expansions using the latest swing down (external Fibonacci retracements), off the back of the swing up before our reversal entry (alternate fibonacci retracements), and finally, by projecting a move that is precisely 200% of the recent upmove, from the top of the most recent pivot high projected downwards, i.e. from the high above the stop loss, to the low before the trade was placed, and beyond by 100% of that move, to include internal retracements.

See the section of the site on Fibonacci retracements, extensions, expansions, and alternate extensions for more information on these.

Price touch of lower bollinger band

As the price continues to drop, it finally hits the new position of the lower Bollinger band on the H1 chart, at 5350.

Cluster of fibonacci retracements/expansions

Thus, we can see a cluster of external Fibonacci lines, using both the most recent swing up which we are deeming corrective, and the most recent swing down, which we are deeming impulsive for the purposes of this trade.

Target of lower bollinger band with fib cluster

As can be seen in the chart, 4 hours after the entry candle, the price reaches the target of the bottom Bollinger band line on the H1 chart – the sensible first target given the sideways trading context on this timeframe.

Sensible flexibility on target

Since this level is 5350, even though the strict 1:2.5 take profit is 5348, it would surely be sensible to accept 5350 as level in itself that is likely to bounce (round 50), which is also the fibs triple cluster area as shown above.

Fib clusters described

Looking at the fib clusters (where levels are almost even with each other), clearly, the 114.6 fib of the most recent downswing is confluent with the 132.8 fib of the prior upswing, which in themselves are in alignment with the lower Bollinger band target – too much to ignore for the sake of a couple of pips.

Notice also how the double cluster of fibs above the ‘Fibs + BBand Cluster’ also acts as a line of symmetry for some choppy market behaviour.

Managing the trade with trailing stops

In spite of many clues pointing to 5350 being a sensible area to make like the wind with profit in our wings, the trade can still be managed using trailing stops as follows.

Aiming for fibs triple cluster

Management of the trade follows the lower timeframe, still aiming for the fibs triple cluster (2.5 x take profit), but locking in profits using a trailing stop method.

New swing low

As per the figure above, a new M15 swing low is established 2 hours and 45 minutes after entry, as marked by the first red elipse.

Correction high

As mentioned above, the swing correction is confirmed by the multiple testing near the entry level forming a region of sideways flow after the entry with a clear top.

The break of the low and close beneath it confirms the new swing is being established from the point of the close of the candle whose lower wick protrudes through the elipse.

Swing trading stop management

The stop can then be brought above the correction high, effectively placed at the break-even point, as per standard swing trading rules.

The trade is now using the market’s money, with risk reduced from 12 points to 0 points.

Target reached

Just a few candles later, the target of the lower Bollinger band on the H1 is reached, and strongly rejected, hitting a triple confluence point.

Confluence zones

The first element of the confluence zone is the Bollinger band H1 lower line as we mentioned.

The second is the 132.8% retracement of the prior upmove, the third is the 114.6% extension of the prior downmove.

Such clusters form likely areas of reversal.

Trailing stop management of the trade

If the trade was not exited for whatever reason at the 2350 level, we are now sitting with a stop at break even, above the most recent correction high, using swing trading rules.

There is now a significant period of consolidation and thin liquidity, mainly due to market hours, which have not been considered thus far, and add to the reasons to have got out at 2350, or at the retrace to 1:2 as a consolation.

However, eventually, the market does create a new swing low as marked by the second red elipse.

At this point, the stop can be brought down to the level just whisker above the candle that did bounce off the original target of the lower Bollinger band, which has formed a correction high.

Eventually, this stop does get taken out at 5360, for a profit of 18 Nasdaq points, for 12 risked initially, that is to say, 1:1.5 eventual risk reward.

There are a number of alternative trade and risk management techniques that could have been employed by the savvy trader.

These are discussed at length in the sections on trading risk management.

Conclusion

In conclusion, we began in article 1 with a rules-based system for describing market momentum using averages, identifying potential reversals in the trend with filters (the Bollinger bands and 20SMA, plus the stochastic oscillator).

We went on to go through a worked example using an operational timeframe (M15) and a confirmatory, higher timeframe (H1) and traced the trade from start to finish, including stop loss, entry, forecasted projections and finally, trade management using either a confluence exit, or trailing stop.

Coming soon... signals every day. Pepperstone Group Limited

A moving average reversal, trend and momentum based trading system—example NASDAQ trade

Review

In the last article in this series, we introduced a way to establish intraday momentum on the M15 and the H1 charts, using only moving averages, with Bollinger bands for confirmation of viable trend exhaustion (a reversal).

Let us take the basic anatomy that we have explored and the trade that was identified on the NASDAQ cash index chart, and explore the follow on from that.

We suggested that given the matrix in the previous post, the downward bias can be clearly seen, with the full short term momentum signalling down on the M15 chart, and the first warning on the H1 chart.

Furthermore, recently, the price action had touched the upper Bollinger band on both charts, informing us of a possible trend exhaustion coming up.

Chart setup – M15 and H1

Here are the two charts as a reminder.

Chart 1 – 15 minute chart of NASDAQ cash index

Figure 1. NASDAQ cash index 15 Minute chart.

Signal candle

The signal candle for entry using the system we have built up is the last candle showing on the chart (close of the 1st candle in from the right).

The entry candle has offered a greater price change than any of the preceding 8 candles, and has closed very easily within its bottom 25%, it is a classic momentum down candle, closing also nicely below all three of our short term momentum averages.

Stochastic Oscillator

Notice also that a Stochastic oscillator (14,3,3) has been added and the main line is diverging away from the signal line, and both are pointing downwards, having just breached the 80 level from above, another good sign that we are on the right track.

The downward sloping longer term averages support the directional bias of the trade and add confidence to the entry.

One Hour Chart

Entry, stop and target price

On the one hour chart, we add the entry price, the stop and a 1:2.5 risk reward target to the H1 chart.

Bollinger bands sidways

We earlier noted that the H1 Bollinger bands were trading sideways, in which case, the bottom Bollinger band should be a serious candidate for a bounce.

Price should range between the bands in such a condition.

Entry candle from the one hour chart

Below is the entry as it looks on the H1 chart, the entry being the close of the rightmost candle.

The 3EMA ‘Elbow’

Note the acute elbow-like hook on the 3EMA, which forms our warning 1, given that it closes below the 5SMA on this chart.

One hour chart of NASDAQ cash index

NASDAQ cash index trading strategy

Stop loss

The stop is 12 Nasdaq points from the entry, including spread (5390 VS 5378, respectively).

This level is sufficiently tight, but still above the 88.6% retracement of the H1 candle, what I call the ‘point of no return’.

Alternative stop

An alternative stop would be just above the high of the H1 candle, but no higher, unless we were trading from an H2 chart, which we are not in this case.

Target risk reward level

The ultimate target of 1:2.5 risk reward is conveniently tucked below the current level of the Bollinger band lower line, which we believe will be hit in a sideways market, at level 5348.

We are therefore looking for the momentum to take the Bollinger band itself lower than its current sideways static level, as the market travels down, in order to reach this satisfactory risk reward area.

Trade progression

Following from our previous look at a trade triggered by confluent indications of a downward move starting from the M15 chart, leading the H1 chart and giving a high probability of reaching the bottom Bollinger band, after a reversal near the top of the H1 bollinger bands, sufficient momentum from the moving averages trading system described here.

Let us see the progression of the trade now, using the M15 chart and introduce some more advanced technical forecasting techniques, and visualise the risk management strategy.

Progression of the trade on the 15 minute chart

Complete trade evolution

The above chart shows the evolution of the trade from start to finish, using the operational timeframe, namely, the M15.

This article is continued by using some more advanced technical analysis and trade management techniques.

Coming soon... signals every day. Pepperstone Group Limited