“What comes up would always come down!”
Reversal signals coming from overbought or oversold market levels are inherently high probability momentum reversal trade setups. This is because such price extremes are often unsustainable. Sooner or later, market participants would find such market condition uncomfortable and price would reverse.
The trading strategy about discussed is a reversal trading strategy which capitalizes on the confluences of reversal trading signals using two technical indicators.
Super Passband Filter 2 Indicator
The Super Passband Filter 2 Indicator is a customized oscillator type of indicator, developed by John Ehlers, which utilizes a smoothing technique based on analog filters. It was designed to filter out unnecessary outliers produced by price spikes which most smoothing methods are prone to, while at the same time reduce the lag which is also a common weakness for many indicators. To achieve this, John Ehler’s developed the algorithm behind this indicator to reject both high and low frequency components within the price data in order to minimize both noise and lag.
This indicator plots a smoothened oscillator line which oscillates around zero. This line is the main Super Passband Filter line. Market direction or momentum may be observed based on where the line is in relation to zero. Positive values indicate a bullish momentum bias, while negative values indicate a bearish momentum bias. Crossovers between the line and zero may also be used as a trend or momentum reversal signal.
The Super Passband Filter 2 Indicator also incorporates the concept of Root Mean Squares (RMS) to indicate price extremes. It plots two lines which envelope zero. The upper line is the +RMS line, while the lower line is the -RMS line. The market may be considered overbought whenever the oscillator line is above the +RMS line and oversold whenever the oscillator line is below the -RMS line. As such traders may also anticipate potential market reversals whenever the market is in either price extremes.
Since the Super Passband Filter 2 Indicator is an oscillator type of technical indicator, it can also be used to identify possible reversals based on divergences. Traders can use this parameter as an additional confluence when looking for possible market reversal scenarios.
Pin Bar Indicator
Candlestick patterns are repeatable patterns that can be observed on a candlestick chart. These patterns are effective indicators potential momentum reversals. This is because candlestick patterns tell a story of how the market is behaving in relation to certain price levels.
The Pin Bar Pattern is probably one of the most widely used candlestick pattern because of its efficacy. This is because the pin bar pattern tells a story of how price is rejecting a certain market direction or price level.
The Pin Bar Pattern is composed of one candlestick. It is a candle which has a small body and a long wick on one side. The direction of the momentum reversal can be identified based on where the long wick is in relation to its small body. The momentum is bullish whenever the long wick is below the small body of the candle, and bearish whenever the long wick is above the body of the candle. Imagine the long wicks as the leg of the candle kicking against a support or resistance level.
The Pin Bar Indicator is a custom technical indicator which automatically identifies the pin bar patterns. It plots a green and red diamond symbol above and below the candle to indicate that the candle is a pin bar pattern. The direction of the pin bar pattern signal is indicated by the location of the green diamond symbol. It is bullish whenever the green diamond is above the candle, and bearish whenever the green diamond is below the candle.
Trading Strategy Concept
Super Passband Filter Divergence Forex Trading Strategy for MT5 is a reversal trading strategy which trades on divergences, price rejections, and overbought or oversold market conditions.
The Super Passband Filter 2 Indicator is mainly used to identify overbought and oversold markets. This is based on whether its main oscillator line is above the +RMS line or below the -RMS line.
Aside from the overbought and oversold condition, traders should also observe for possible divergences based on the oscillations of the Super Passband Filter line.
If the conditions above are met, traders may then look for possible trade entries. Trade signals are considered valid based on a pin bar pattern, which can be identified by the Pin Bar Indicator.
Buy Trade Setup
Entry
- The Super Passband Filter 2 line should drop below the -RMS line.
- A bullish divergence should be observed between the oscillations of price action and the Super Passband Filter 2 line.
- A buy trade entry would be valid if the Pin Bar Indicator would identify a bullish pin bar pattern plotting the green diamond symbol above the candle and the red diamond symbol below the candle.
Stop Loss
- Set the stop loss below the pin bar pattern.
Exit
- Set the take profit on the next swing high level above the entry candle.
Sell Trade Setup
Entry
- The Super Passband Filter 2 line should breach above the +RMS line.
- A bearish divergence should be observed between the oscillations of price action and the Super Passband Filter 2 line.
- A sell trade entry would be valid if the Pin Bar Indicator would identify a bearish pin bar pattern plotting the green diamond symbol below the candle and the red diamond symbol above the candle.
Stop Loss
- Set the stop loss above the pin bar pattern.
Exit
- Set the take profit on the next swing low level below the entry candle.
Conclusion
Individually, the concepts discussed above, such as overbought and oversold market conditions, divergences, and price rejections, are strong indications of a possible market reversal. Some traders would even use these individual indications as the focal point for their reversal trade setups. This strategy combines the three elements by looking for confluences between the three. For this reason, the trades produced by this setup may be fewer, but are often times more reliable. This could even be made more reliable if incorporated with other reversal trade setups.
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