Color Parabolic SAR Trend Continuation Forex Trading Strategy for MT5

January 30, 2024

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Trend continuation strategies often produce high-probability trade setups. This is because its trade setups are hinged on the idea of trading in the direction of the trend. In a way, traders are trading with the “current” of the market when trading trend continuation setups. This strategy shows us how we can objectively trade trend continuation setups using two trend-following indicators.

Color Parabolic SAR

The Color Parabolic SAR is a custom technical indicator which is a variation of the Parabolic SAR or PSAR indicator, developed by J. Wells Wilder.

SAR refers to “Stop and Reverse”. The Parabolic SAR indicator was developed to predict when short-term momentum swings would stop and reverse to the opposite direction.

The Parabolic SAR indicator uses the elements of an Acceleration Factor (AF) and Extreme Point (EP) within its algorithm to identify the thresholds of a trend.

In an upswing momentum scenario, the indicator would subtract the prior Extreme Point from the prior PSAR, and then multiply the difference with the prior Accelerator Factor. It would then add the product to the prior PSAR to arrive at the current Rising PSAR.

RPSAR = Prior PSAR + [Prior AF (Prior EP – Prior PSAR)]

Inversely, in a downward momentum scenario, the indicator calculates for the difference between the prior PSAR and prior EP, and then multiplies the difference with the prior AF. It then subtracts the product from the prior PSAR to arrive at the current Falling PSAR

FPSAR = Prior PSAR – [Prior AF (Prior PSAR – Prior EP)]

The calculations between the RPSAR and FPSAR shift whenever price breaches the trailing thresholds.

This version of the Parabolic SAR plots a blue-violet symbol below price action whenever it detects a new uptrend and plots a trailing blue dot representing the Rising PSAR. On the other hand, it also plots a deep pink symbol above price action whenever it detects a new downtrend and plots trailing red dots to represent the Falling PSAR.

Traders can use the appearance of the symbols as an indication of a trend or momentum reversal. The trailing dots can also be used as a basis for placing and trailing the stop loss, with the assumption that if the price breaches these levels, the trend should have already reversed.

Kumo – Ichimoku Kinko Hyo

The Ichimoku Kinko Hyo is a trend-following indicator that uses several elements within its system to represent the trend direction based on various time horizons. These elements are the Tenkan-sen, Kijun-sen, Senkou Span A, Senkou Span B, and the Chikou Span.

The Senkou Span A and Senkou Span B lines are often used to represent the long-term trend horizon. Together they form the Kumo, which means “cloud”. Traders can use the Kumo as a basis for identifying the long-term trend direction.

The Senkou Span A line, which translates to the Leading Span A line, is the average of the Tenkan-sen and Kijun-sen lines shifted 26 bars ahead. It is calculated by adding the Tenkan-sen and Kijun-sen lines, then dividing it by two, then plotting its data point 26 bars ahead.

The Senkou Span B line, or Leading Span B line, is the median of price within a 52-bar period also shifted by 26 bars ahead. It is calculated by adding the highest high and lowest low within a 52-bar period, then dividing it by two, then shifting the data point by 26 bars.

The color of the Kumo changes depending on which of the two lines is over the other. The indicator shades the area within the Kumo sandy brown to indicate an upward long-term trend and thistle to indicate a downward long-term trend.

Trading Strategy Concept

This trading strategy is a trend continuation strategy that trades on the confluence of a long-term trend direction bias and a momentum swing reversal using the two technical indicators discussed above.

First, the Kumo is used to identify the long-term trend direction. This is based on the location of price action about the Kumo, as well as the color of the Kumo.

As soon as the long-term trend direction is identified, trades are then narrowed down to trading only in the direction of the long-term trend.

The Color Parabolic SAR indicator is then used as the trade entry signal. The appearance of the blue-violet and deep pink symbols are used as the trade entry signal with the assumption that the price would swing in the indicated direction as the price extends the trend further.

The trailing Parabolic SAR dots are then used as a basis for a trailing stop loss to protect profits as the price swing continues.

Buy Trade Setup

Entry

Price action should be above the Kumo while the Kumo is sandy brown.
Price action should pull back causing the temporary appearance of the deep pink Color Parabolic SAR symbol.
Open a buy order as soon as the Color Parabolic SAR indicator plots a blue-violet symbol.

Stop Loss

Set the stop loss below the blue-violet symbol.

Exit

Trail the stop loss below the blue dots until stopped out in profit or close the trade as soon as the Color Parabolic SAR indicator plots another deep pink symbol.

Sell Trade Setup

Entry

Price action should be below the Kumo while the Kumo is thistle.
Price action should pull back causing the temporary appearance of the blue-violet Color Parabolic SAR symbol.
Open a sell order as soon as the Color Parabolic SAR indicator plots a deep pink symbol.

Stop Loss

Set the stop loss above the deep pink symbol.

Exit

Trail the stop loss above the red dots until stopped out in profit or close the trade as soon as the Color Parabolic SAR indicator plots another blue-violet symbol.

Conclusion

This strategy should provide trade setups which relatively have a higher win probability compared to other trade setups. However, because the trade signals that it produces are based on technical indicators, the trade setups that it generates are often lagging. This somehow affects the risk-reward ratio of the trade, which can often be just a little above 1:1. Also, when using this strategy, traders should also consider the market condition as this strategy could produce false signals when used in a non-trending market environment. It should be used exclusively in a trending market condition with relatively wider price swings for the best results.