Reversal trade setups are some of the most difficult trade setups to predict. However, when anticipated correctly, reversal trades have the potential to produce high yielding trades.
One way to increase the probability of a reversal trade is by finding confluences between reversal signals.
This strategy is a reversal strategy based on the confluence of a mean reversal signal and a short-term trend reversal signal using the Super Passband Filter Indicator and a moving average crossover signal.
Super Passband Filter Indicator
The Super Passband Indicator is an oscillator type of indicator which is based on an oscillator indicator developed by John Ehlers. It was developed for the purpose of eliminating market noise which cause signal lines of various oscillators to fluctuate erratically during market spikes. At the same time it also attempts to eliminate lag which is common among various oscillators.
This indicator plots a signal line based on the difference between two Exponential Moving Average (EMA) lines, which are preset as the 40 EMA and 60 EMA. It then calculates for the line by summing its square over n periods, which is preset at 50. The line it plots oscillate around its midline which is zero.
The variables mentioned above can be modified within the indicator input settings. It also allows users to choose from a wide variety of price points from each price candle. This includes the standard open, high, low, and close, the typical price, weighted price, and median price, and even various price points based on Heiken Ashi Candlesticks.
This indicator also plots dotted lines which form bands which are similar to volatility bands. These bands are called the RMS lines. These lines can be used to identify mean reversals coming from overbought and oversold price levels.
A signal line which is above the upper volatility bands is indicative of an overbought market, while a signal line which is below the lower volatility bands is indicative of an oversold market. The indicator also shades the area between the signal line and the volatility bands whenever the market is either overbought or oversold for easier identification. Signal lines crossing the outer lines coming from overbought or oversold territory are indicative of a potential mean reversal signal.
7 SMA and 21 SMA Crossover
Moving average crossovers are some of the most basic trend reversal trading strategy which many traders use. It is a strategy which is easy to follow as traders simply interpret the crossing over of two moving average lines as a trend reversal signal.
Crossovers wherein the faster moving average line crosses above the slower moving average line is indicative of a bullish trend reversal, while crossovers wherein the faster moving average line crosses below the slower moving average line is indicative of a bearish trend reversal.
Moving average crossovers can be effective tools for identifying trend reversals. However, not all moving average crossover signals can be accurate. There are several moving average crossover pairs which seem to be more popular than others.
The seven bar and 21-bar Simple Moving Average (SMA) lines is one of the more popular moving average crossover signals. This moving average crossover pair tends to produce short-term trend reversal signals.
It is not perfectly accurate. In fact, it should not be used as a standalone trade signal without consideration for other technical analysis indications. However, when traded in confluence with other technical analysis setups and indications, this moving average crossover pair can be an effective trend reversal confirmation.
Trading Strategy Concept
This trading strategy is based on the concept of trading mean reversal signals coming from overbought and oversold price levels using the Super Passband Filter Indicator as a means to identify such market conditions.
The mean reversal signals are based on the crossing of the Super Passband Filter signal line over the volatility bands heading back towards the center of the oscillator range, with the hope that momentum would cause it to swing to the opposite extreme of the range.
These mean reversals are traded not as a standalone signal. Instead, these signals are traded in confluence with 7 SMA and 21 SMA crossover reversal signal as an additional confirmation.
Buy Trade Setup
Entry
- The Super Passband Filter signal line should be below the lower volatility line indicating an oversold market.
- The signal line should cross above the lower volatility line.
- The 7 SMA line should cross above the 21 SMA line.
- Open a buy order on the confluence of the reversal signals mentioned above.
Stop Loss
- Set the stop loss on the support below the entry candle.
Exit
- Allow the signal line to swing above the upper volatility line, then close the trade as soon as the signal line starts to slope down.
- Close the trade if the 7 SMA line crosses below the 21 SMA line.
Sell Trade Setup
Entry
- The Super Passband Filter signal line should be above the upper volatility line indicating an overbought market.
- The signal line should cross below the upper volatility line.
- The 7 SMA line should cross below the 21 SMA line.
- Open a sell order on the confluence of the reversal signals mentioned above.
Stop Loss
- Set the stop loss on the resistance above the entry candle.
Exit
- Allow the signal line to swing below the lower volatility line, then close the trade as soon as the signal line starts to slope up.
- Close the trade if the 7 SMA line crosses above the 21 SMA line.
Conclusion
This trading strategy is a decent reversal strategy with relatively accurate reversal signals compared to most trend reversal trading signals. This is because the reversal signals it produce are based on a confluence of a mean reversal signal and a short-term trend reversal signal. Having such confluence allows for a higher win probability.
The signals this strategy produces is not perfectly accurate. There are times when the signals produced would not result in a swing to the opposite extreme. At times, the price swings are shorter compared to the risk placed on the trade. At times, the reversal signals do not result in actual reversal. For this reason, it would still be best to trade these signals in confluence with other technical analysis indications such as those based on price action.
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