Momentum Trading Strategy: USD Pairs Part 3

By: DailyForex.com

A few weeks ago, I wrote an article explaining how the best Forex momentum trading strategy of recent years has been trading USD currency pairs in the direction of the 3 and 6 month trends when they both agree. I did not get into the specifics of how this could be traded, but just used a back test to show how simple opening a position at the beginning of each week, hypothetically, could have made great returns over a recent 14 year period.

Of course, most traders would find this an impractical method to trade: although it is very easy, the absence of a stop loss or any other kind of optimization can make it a psychologically uncomfortable trading experience. In this article, I am going to explain what I believe is the best way to execute this kind of trend trading.

Multiple Time Frames & Moving Averages

We have already established that the best way to successfully trend trade Forex is to trade non-exotic USD currency pairs long when the price is above where it was both 6 months and 3 months ago, and short when the situation is reversed. So this is rule number 1: every day, mark where the price was 3 months and 6 months ago, and only enter a new trade when the price is above or below both of these levels.

The second rule is to enter a trade only when a fast exponential moving average crosses a slower simple moving average in the direction of the trend. I like to use the 3 period exponential moving average as a fast moving average, and a 10 period simple moving average as the slower moving average, as I find it works well.

The third rule is to use the 1 hour time frame for entries, but to make sure that the 10 period simple moving average is working as a filter on the other higher time frames. You can achieve this by just using an H1 chart and putting simple moving averages of 40 periods (representing the 4 hour time frame), 240 periods (representing the 1 day time frame), and 1200 periods (representing the 1 week time frame). If the price at the moment of a cross of the 3 period exponential moving average above the 10 period simple moving average on the 1 hour time frame is not above all of these other moving averages, for example, there would be no trade.

Additional Entry Rules

I am just going to quickly mention here two additional entry rules on the side, so to speak, because I want to continue with our train of thought.

First of all you should probably use a stop loss, even though this strategy calls for time-based trade exits, and even though I will go into the details of a back test which shows this is a very profitable method overall even without a stop loss. This is simply to try to protect you from any very large losses. Another thing you really must do is make sure that you do not trade any currency pairs where one or both of the currencies is pegged by its central bank to another currency. Please remember that the Swiss Franc rose in value by more than 10% and your stop loss was worthless with every broker. So consider that your loss on a single long trade there would have been your entire account at leverage of 10 to 1 and more than that at any higher amount of leverage!

A stop loss equal to the 20 day average true range of the currency pair you are trading should work perfectly well.

Another thing you can do if you have the time is make sure all the lower time frames are in agreement before entering upon a cross on the 1 hour time frame. This should keep you out of a few bad trades, but if you do not have the time, do not worry about it too much.

Of course, most traders would find this an impractical method to trade: although it is very easy, the absence of a stop loss or any other kind of optimization can make it a psychologically uncomfortable trading experience. In this article, I am going to explain what I believe is the best way to execute this kind of trend trading.

Finally, position sizing is up to your own tolerance for draw-downs, but professional trend traders often recommend risking about 0.20% of equity per trade.

Special Trade Exit Rules

Traditionally, trend traders aim for fixed profit targets, or exit a trade when it starts to turn against the desired direction. There are drawbacks with both of these methods. I believe that far better results can be achieved in trend trading Forex by using time-based exits of 5 hours and 48 hours.

After entering a trade, forget about it for 5 hours, then check on its progress. The amount of 5 hours was chosen based upon the old trading maxim that a candlestick’s effect in the market only lasts for the next 5 hours. If the trade is not in profit, then close it right away at its loss. If the trade is in profit, then leave it for another 43 hours to complete the 48 hour cycle. When the 48 hours is complete, just close the trade whether it is at profit or loss.

It is surprising that such a simple and seemingly crude method for exiting trades can work so well, but unless you are a really good and very experienced trader, picking exits manually is very likely to get you much worse results. This method can take all the stress out of trade management. It is actually more profitable overall to just leave all the trades for 48 hours regardless of how they are doing after 5 hours, but adding this 5 hour rule tends to help most people psychologically, and prevent a strong of large losses.

You might not want to open more than one trade per day per currency pair, as sometimes there can be a cross backwards and forwards more than once per day, although these multiple trades are included in the back test results.

Back Test Results

This strategy was applied to three major USD currency pairs over a very recent 13 year period, without the 5 hour filter, and without stop losses. The results are shown below.

Trading strategies 2

trading strategies 1

During this entire period, the maximum number of consecutive losing trades was 19 trades, and the largest draw down was about 40 units, compared to a total profit of 1,000 units.

It is an easy strategy to master so why not get practicing by opening a demo account? Feel free to comment here with any questions and feedback.

Adam is a Forex trader who has worked within financial markets for over 12 years, including 6 years with Merrill Lynch. He is certified in Fund Management and Investment Management by the U.K. Chartered Institute for Securities & Investment. Learn more from Adam in his free lessons at FX Academy.