There are a couple of ways traders identify the resumption of a trend in trend continuation strategy. One is by observing for price rejection at certain price levels. Another would be by observing the resumption of a strong momentum in the direction of the trend.
This strategy is a trend continuation strategy based on momentum. It uses the 50 SMA line and the Price Channel Indicator to objectively identify potential trend continuation opportunities.
Price Channel Indicator
The Price Channel Indicator is a channel or band type of indicator which indicates trend and momentum direction based on price action movements.
This indicator detects and identifies the highest highs and lowest lows within a given time window, which is preset at 22 periods. However, this variable can be modified within the indicator input settings.
It then marks the range of the highest high and lowest low for the given n bars. The area is shifted one bar to the right and shaded dodger blue.
The indicator also identifies the median of the range, which is simply calculated by adding the highest high and the lowest low, then dividing it by two. It then plots a blue line marking the median of the range.
Given the mechanics of how the range and its middle line is identified, this indicator plots a channel like structure and a line that moves in a staircase like manner. This is even more evident whenever the market is trending.
This indicator can be used to identify trending markets based on where price action generally is in relation to the middle line. The market is in an uptrend whenever price action is generally above the middle line, and in a downtrend whenever price action is generally below the middle line.
The area around the middle line can also be used as a dynamic support and resistance area especially during trending market conditions. Price may pullback and stop around the area of the middle line before the market momentum would resume in the direction of the trend.
50 Simple Moving Average
The 50-bar Simple Moving Average (SMA) is one of the most popular moving average lines commonly used by traders. In fact, it is widely regarded as one of the main mid-term trend indicators.
Traders often interpret the mid-term trend direction based on where price action generally is in relation to the 50 SMA line. The market is in an uptrend whenever price action is generally above the 50 SMA line, and in a downtrend whenever price action is generally below the 50 SMA line.
Since moving averages follow price, the 50 SMA line usually curls and slopes towards the direction where price action is. As such, traders can also identify trend direction based on the slope of the 50 SMA line. It slopes up whenever the market is in an uptrend, and slopes down whenever the market is in a downtrend.
Many seasoned traders use the 50 SMA line as a trend direction filter. In such a rule, trend following traders would avoid trading against the trend direction indicated by the 50 SMA line. They would not take buy trades whenever price action is below the 50 SMA line and sell trades whenever price action is above the 50 SMA line. They would only trade in the direction indicated by the 50 SMA trend.
Aside from this, the 50 SMA line can also act as a valid dynamic support or resistance level. Price may bounce and reverse as soon as it touches the 50 SMA line reverting back to the direction of the trend.
Inversely, some also use the 50 SMA line as a trend reversal signal. Some implement this based on the crossover of price and the 50 SMA line or the crossover of a faster moving average line and the 50 SMA line.
These concepts are practically polar opposites, which is why it is sometimes confusing which direction to trade as price touches the 50 SMA line. Some would even avoid trading as price action would start to challenge the 50 SMA line and would rather wait for a confirmation of either a trend continuation or a reversal.
Trading Strategy Concept
This trading strategy is a trend continuation strategy which uses the 50 SMA line and the Price Channel to identify and confirm trend continuation setups.
The trend is identified based on where price action generally is in relation to the 50 SMA line, as well as the slope of the line. Another layer of trend confirmation is also added to ensure that the market is trending in one direction quite significantly. This would be based on where the middle line of the Price Channel is in relation to the 50 SMA line.
We would the wait for price action to retrace near the 50 SMA line to the point of crossing and closing on the opposite half of the Price Channel going against the trend. We would then wait for a momentum candle to cross the middle line of the Price Channel and close strongly in the direction of the trend.
Buy Trade Setup
Entry
- Price action and the middle line of the Price Channel should be above the 50 SMA line.
- The 50 SMA line should slope up.
- Price should pullback below the middle line of the Price Channel.
- Open a trade as soon as a bullish momentum candle closes above the middle line of the Price Channel.
Stop Loss
- Set the stop loss below the candle.
Exit
- Close the trade as soon as price closes below the middle line of the Price Channel.
Sell Trade Setup
Entry
- Price action and the middle line of the Price Channel should be below the 50 SMA line.
- The 50 SMA line should slope down.
- Price should pullback above the middle line of the Price Channel.
- Open a trade as soon as a bearish momentum candle closes below the middle line of the Price Channel.
Stop Loss
- Set the stop loss above the candle.
Exit
- Close the trade as soon as price closes above the middle line of the Price Channel.
Conclusion
This trading strategy uses momentum to identify the resumption of a trend. It can be an effective trend continuation strategy when deployed in an appropriately trending market. However, it can also produce losses whenever the market trend is weak or whenever the market is ranging or choppy. It is critical that traders should first observe the nature of the current market condition before deploying this strategy.
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