Trend-Reversal Strategy

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Trend-Reversal Strategy (TR Strategy) is based on a combination of two exponential moving averages and Awesome Oscillator Indicator. The main idea of TR strategy is to find turning points of the trend and trade against the current trend.

Strategy

Trend-reversal strategies are based on simple principle, to spot the end of trending movements and get profit from newly forming trends. Such strategy has a high percent of false signals because trend movements on the markets have wave structure. This waves of the trend can be easily confused with trading signals. On the other hand, when the trend changes direction, such strategy can yield high profit, many times greater than risk level.  TR strategy bases on a classic combination of fast and slow EMA’s, also accompanied with Williams Awesome Oscillator (AO).

EMA’s

The classic combination of fast, 21 period EMA, and slow, 70 periods EMA, are used to identify trend direction and confirm trading signals. Also, the strategy relies on crossovers of slow EMA with price as triggers for trading signals. Since trend-reversal strategy seeks for reversal points, buy signal can occur only during a downtrend, and vice versa. These moving averages show current trend direction.

  • Fast EMA located above slow EMA – Bullish trend
  • Fast EMA located below slow EMA – Bearish trend

Williams Awesome Oscillator

Awesome Oscillator Indicator was created by B. Williams as a modification of MACD indicator. Roughly speaking, this oscillator shows the difference between fast and slow SMA Values. This difference is plotted as a histogram of red and green bars. The green bar indicates that its value is higher than the previous bar, Red bar indicates that it is lower than the previous bar.  By the B. Williams convention, Awesome Oscillator relies on 34 periods SMA and 5 period SMA.

Trend-Reversal Strategy 0

Red bars follow strong downward movements; Green bars follow strong upward movements. Indicator oscillates around zero level. Usually, traders consider 5 bars of the same color in a row as a strong trading signal. AO Indicator serves as confirmation indicator for trading signals.

 

Rules for the strategy:

TR strategy is sensitive to market noises and spikes, so the lowest recommended time-frame is 1H. Rules of the strategy can be divided into three logical steps:  Trend recognition; Basic Signal of the trend reversion; Signal confirmation. Trend recognition part bases on a combination of the EMA’s. The primary signal occurs when price bar crosses slow EMA, and Awesome Oscillator shows high trend power. Fast EMA crossing slow EMA and signaling about new trend direction confirms trading prediction.

Setup

This strategy fits better on timeframes greater than H1. Also, the trader should always take into account the macroeconomic events to use them in its favor or to avoid high volatility and irregular periods.  Rules:

  • Any trading instrument is suitable. FOREX currency pairs are favorable.
  • To prevent the impact of market noise we recommend to use time frames higher than one-hour bars;
  • Install EMA Indicator with period of 70
  • Set second EMA indicator with period of 21 bar
  • Install Awesome Oscillator Indicator

Trend-Reversal Strategy 1

EURUSD H1 chart with EMA(70), EMA(21) and Awesome Oscillator.

Entry rules

Buy Signal:

  • Fast EMA(21) are lower than slow EMA(70) – Bearish trend
    • Price bar has direction upward and closes higher than slow EMA(70); AO has at least five green bars in a row – Buy signal
      • Fast EMA crosses the slow EMA from the bottom up – Buy Signal Confirmation

Sell Signal:

  • Fast EMA(21) are higher than slow EMA(70) – Bullish trend
    • Price bar has downward direction and closes lower than slow EMA(70); AO has at least five red bars in a row – Sell signal
      • Fast EMA crosses the slow EMA from top to bottom – Sell Signal Confirmation

 

Exit rules

The strategy allows several exit rules. In addition to the stop loss and take profit levels there are Early Exit rules. Notably, such type of strategies often uses big Take Profit, so trades closes mainly by Early Exit rules or by trailing stop.

Stop Loss

There are several rules to evaluate Stop Loss, which underlay different risk levels. Usually, Stop-Loss set to the support levels and pivot points. Important thing to remember is that all Stop Loss rules have to correspond to one main rule: Stop Loss should always be behind the alleged peak of the trend. These rules are listed for the Buy signal, for the Sell signal rules should be vice versa.

  • Behind peak of the trend
  • Closest lower Pivot Point
  • Lower Resistance level

Take Profit

Take Profit is the desired level of profit and must correlate with Stop Loss level. One of the most important indexes of the strategy is relation SL/TP. This relation is called risk/reward ratio of the strategy. For EMAOA strategy risk/reward ratio has to be lower than one.  (rules are for the Buy signal):

  • Closest upper Pivot Point
  • Upper Resistance level
  • Last significant Peak

Early exit rules

If the trade opened and confirmed, so the trend forming in the favorable direction the only scenario to close the trade is an end of the new trend. There are couple methods, with different risk levels, to identify trend reversion:

  • Reverse signal of Trend-Reversal Strategy – high risk
  • Fast EMA crossing slow EMA back, which indicates possible end of the trend – medium risk
  • Awesome oscillator gives five same-colored bars in a counter direction – low risk

Examples

Trend-Reversal Strategy 2

EURUSD H1 chart; Stop-Loss set couple point below trend peak; Medium risk rules for the Early Exit.

The strategy gave two profitable trades, Sell with 60 and Buy with 190 points of profit.

For the ideal market, the strategy would alternate between buy and sell signals. Therefore, traders often wait for buy signal only after sell signal and vice versa.

Pros

A good strategy for catching big moves. Possible reward is much higher than risk.

Cons

High volatility and noises could cause a lot of false signals.

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