An exotic technical trend-following strategy in FX.

A personal trading strategy I like to use to follow the trend.

Many technical strategies do not make a lot of economic sense and are the result of extensive back-testing and data mining. Some are genuine and tend to work while others seem to only work when specific conditions are met. This is what I’m hoping to achieve by presenting one of my favourite trend-following strategies. But first, what is trend-following? It’s a type of trading that is:

  • Searching for selling opportunities during a falling market.
  • A short-term Stochastic indicator set at a lookback period of 5.
  • A mid-term Stochastic indicator set at a lookback period of 14.
  • A Fibonacci expansion tool to measure targets and potentials.

1 . Trend detection

The first step is to look for a trending series either through a moving average or through visual interpretation. I tend to prefer long-term moving averages such as 100 and 200 so as to be sure of the pre-established trends. During lucky times, the moving averages can provide an extra layer of support/resistance level from where we initiate our trigger. Below is an example on the USDCAD where we can clearly see that the trend is bullish.

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Bullish direction on the USDCAD giving us the signal that we want to search for buying opportunities.

2 . Finding the trigger intervals

The next step seeks to find the end of the corrections/consolidations by establishing intervals. How are we going to do that? Simple, by using two Stochastic indicators, we will find the points where both indicators show extreme values. Below is a clear example:

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Coinciding extremes that serve as first building steps in the trend-following system.
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The grey zones are the intervals.

3 . Calculating the potential

This is where the Fibonacci expansion tool comes in. How is the potential calculated? Well, we take the interval, starting from the low of the first candle, project it to the high of the highest candle inside the interval by using the low of the last candle in the interval. Here’s a clear graph to explain the previous statement.

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How to calculate the potential within an interval.
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100% means that the projection is the same amplitude as the first leg.
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Fibonacci expansion tool.

4 . Calculating the risk

As I am a fan of the simple basic risk management principle that says never to risk more than you expect, I like to use a 2:1 risk-reward ratio. This means that if I expect to gain $2, I would risk losing $1. In the below graph, we have the same trade, with the addition of the stop loss that is half the amplitude from the buy-to-target distance.

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Stop-loss level measured using the Fibonacci expansion tool by projecting the target to the entry and taking 150.00% to the bottom. Note that the stop-loss level is the bottom extreme of the dark red area.
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Finding the strategy’s triggers.
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Potential through the Fibonacci expansion tool.
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Stop-loss as half the distance between the entry and the target. Entering at the end of the interval.

CONCLUSION

The best word to describe this strategy is that it is ‘improvised’. Understandably, a pure technical strategy that combines two or more indicators together in man-made measures and rules does not make much sense. In investing and trading we are all looking for something that not only works, but it also has to make economic sense. In technical analysis, this can pose a problem sometimes. However, the strategy per se does not make much sense as technical analysis can at least be explained by the psychological behaviors and market participants. Nevertheless, live trading this strategy produces good returns for a trend-following system that one can use as a supporting strategy.

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https://pixabay.com/photos/business-stock-finance-market-1730089/

Written by

Institutional FOREX Strategist | Trader | Data Science Enthusiast. Author of the Book of Back-tests: https://www.amazon.com/dp/B089CWQWF8

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