Momentum Flag Forex Trading Strategy

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Momentum Flag Forex Trading Strategy

Among all the basic chart patterns, I find the flag pattern to be one of the most effective. At least for my own personal trading though. I’m not sure how many traders also use this, but it sure is very popular in trading.

The advantage of flag patterns though is that it is a trend continuation pattern. This means you will be trading with the trend, instead of against it.

Flag patterns are also a form of contraction. Remember, a trending market is a series of expansions, then contractions, then expansions. With the flag pattern, the pole of the flag resembles an expansion, followed by the flag itself, which signifies contraction, then the breakout from the flag pattern signifies the start of another expansion phase.

momentum flag forex trading strategy 01

Another advantage that the flag pattern usually offers is that the contraction phase is also usually a retracement. This gives traders the opportunity to enter at a better price instead of chasing price around.

On the flip side though, these retracements are also a bit of a challenge because retracements on the higher timeframe are actually whipsaws on the lower timeframe. This means that market entry could be a bit tricky.

Another thing about flag patterns is that breakouts from flag patterns are actually breakouts of resistances in the lower timeframe. As with all resistances, a touch on the area of the resistance could mean two things, either a breakout or a reversal. At times, even when price has closed beyond the resistance, it even reverses back below the resistance.

However, there is a way to increase the probability of entering the trade on the actual breakout. This is by identifying momentum. If a candle does have momentum as it breaks out of the flag pattern, there is a higher chance that price would start to expand again, continuing the major trend.

The Setup: Using Volume to Identify Momentum on Flag Breakouts

To identify candles with strong momentum, we will be using the aid of volume. The hypothesis is that candles with strong momentum coincides with having a higher than average volume traded within the candle.

We will also be using the aid of the 30 & 50 EMAs in order for us to easily identify the trend direction. Also, the 30-50 EMA will be acting as an area of dynamic support or resistance. This will be the area where we will expect the retracement to end and price will start to resume going the direction of the intermediate trend.

What we will be looking for are the following. Probable flag patterns that could break out, volume decreasing as price contracts or retraces, and the direction of the flag pattern should coincide with the trend direction based on the EMAs. Somewhat like the chart below.

momentum flag forex trading strategy 02

Buy Setup:

  • Identify a bullish flag pattern
  • 30 EMA should be above the 50 EMA
  • Price should start retracing from above the EMAs
  • Volume should be decreasing along with the contraction phase
  • The breakout candle should have higher volume compared to the previous candles
  • Enter at the close of the breakout candle

Stop Loss: Set the stop loss below the breakout candle

Take Profit: Set the take profit at 1.5x the stop loss

momentum flag forex trading strategy 03

Sell Setup:

  • Identify a bearish flag pattern
  • 30 EMA should be below the 50 EMA
  • Price should start retracing from below the EMAs
  • Volume should be decreasing along with the contraction phase
  • The breakout candle should have higher volume compared to the previous candles
  • Enter at the close of the breakout candle

Stop Loss: Set the stop loss above the breakout candle

Take Profit: Set the take profit at 1.5x the stop loss

momentum flag forex trading strategy 04

Conclusion

This technique of using volume to determine momentum is commonly used in stocks and is quite effective in doing so. What we are doing is we are just importing the same technique used in stocks to trading. Hopefully it could help improve your trading as well.

However, we should take note also of a few differences in stock trading and forex trading that greatly affects the effectivity of using volume.

Stock trading to me is one dimensional. It is either a buy or a sell. Because it is one dimensional, retracements would often mean prolonged trickle of transactions causing the volume to be lower than usual. Breakouts with momentum on the other hand are usually one directional transactions with higher frequency and volume sizes in a single candle. This causes the volume to spike during the breakout.

Forex trading however, is unlike stock trading which is one dimensional. It is not just a buy or a sell of a currency. Actually, buying one currency also means selling the other and selling one currency means buying the other. To me this means forex trading is two dimensional.

How does this affect our strategy? At times, when there are buyers on both currencies, price would just bob up and down on a tight range, making small candles. But this doesn’t mean that volume is low. It just means that the buyers for both currencies are fighting it out at a smaller range. This gives us small candles with high volumes. What happens is that sometimes, when the breakout candles occur, the volume doesn’t become significantly bigger than the previous candles. For this reason, you would also find flag patterns in the forex market that don’t have volume spike coinciding with the breakout candle. And these flag patterns also work because it actually has one sided momentum. Only that the volume of the previous candles are also quite big because buyers for both currencies are still fighting it out within the range.

So, what is our main takeaway with this strategy? Volume could help us determine momentum candles. But, it is not the main thing when it comes to trading flag patterns. Another thing to take note of is that breakout candles with lesser volume than the retracement might be indicative of a candle with no momentum.

Hope this adds to your knowledge as traders. Study it, tweak it, learn it, trade it.

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