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Trade trends if momentum takes a loss

A dear child has many names. The strategy below is called ‘lost momentum’ in my vocabulary, but it no doubt has other names too. It is in essence a form of trend-following strategy.

Ingredient no. 1: define the trend

I recommend using a simple or exponential moving average (MA) of more than 50 bars. Some have reported good results with the 62-period MA. I don’t want you to get too bogged down with rigid definitions. You are looking for a trending market, which trades above your chosen MA, and the MA is pointing up (for long positions – reverse the instructions below for short positions).

Ingredient no. 2: define your timeframe

You can use this technique on any timeframe. I find it lends itself very well to day trading on the 15-minute chart, and swing trading on the four-hour chart.

Set-up for ‘buy signal’

Your chosen market is trading above your MA indicator and the MA is pointing up. If you observe that the market is taking out a previous low (that previous low must be at least eight bars prior to the current bar), you now wait until the market closes back above the price point of the previous low. That is your buy signal.

Example:
On 15 March 2011 EUR/USD made a low at midnight at $1.3920. However the trend was up on my 30-minute chart. At 8.30am the euro dipped below $1.3920 by about 10 points. It closed below $1.3920 too but, on the very next 30-minute bar, the euro closed back above $1.3920. That is my signal to buy EUR/USD, with a Stop Loss below $1.3920.

The technique stems from the observation that even in a trending market you will often find that price dips below a previous low, only to immediately resume its trend higher. All I attempt to do is to trade in the direction of the trend defined by the moving average. I reverse the instruction above for selling.

Tom Hougaard

Published: 23 September 2011

You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.

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