Trend Reversals are one of the highest yielding types of trading strategies. If done right, traders could easily fetch several hundred pips at a time. This is because trend reversal strategies assume that the end of one trend is the start of another trend. This could mean that traders can enter a trade at the start of a fresh trend and exit the trade as the trend ends.
However, trend reversal strategies are double edged swords. Although trend reversals could produce the highest gains, it is also often difficult to anticipate. This is because not all trends that end would instantly reverse into a new trend. The market could also range prior to starting a new trend. Most traders make the mistake of trading every trend reversal signal that their trading strategy or system produces.
So, how do we identify if a trend is reversing or if it just entering a range? First, we must understand what a trend means. Price action traders would define an uptrend as a market that produces higher swing highs and swing lows. Downtrends on the other hand are defined as markets making lower swing lows and swing highs. Most traders make the mistake of entering a trend reversal setup without first confirming if the market is making higher or lower highs and lows.
Trend Magic Reversal Forex Trading Strategy is a simple trend reversal strategy that makes use of a trend following indicator to help identify probable trend reversals. It makes use of two simple indicators and confirms the trade entry with price action.
50-Bar Exponential Moving Average
Moving Averages are a staple technical indicator for many traders. You would rarely see a trader not using any sort of moving average on their charts, except for those who trade on naked charts, those who trade supply and demand, or those who use market flow strategies. Trend following and trend reversal traders would often use a moving average to identify if the market has reversed. The question is which moving average to use.
When it comes to choosing a moving average, there is no right or wrong choice. Successful traders use whatever works best for them. There is no need to find that elusive magic number whether it is at 144 bars, 27 bars or any broken number. What works most often are moving averages that many traders use. This is because the market is a self-fulfilling prophecy. The more traders use a moving average, the more likely it is that they have the same outlook on the market and the more likely it is that the market will move in their direction.
The 50-period Exponential Moving Average (EMA) is one of the most commonly used moving average line. Traders use it to identify trend bias or anticipate a trend reversal. Traders look at it as a basis for the mid-term trend. Because many traders use it, it is more likely that trade assumptions that are based on the 50 EMA trend would have a higher probability.
Trend Magic Indicator
The Trend Magic indicator is a custom indicator used to identify trend direction. It is based on the Commodity Channel Index (CCI) and the Average True Range (ATR). The indicator combines the information coming from these two indicators to identify trend direction.
The indicator plots a line on the price chart which tends to follow price action quite closely. The line then changes color whenever the indicator detects a trend reversal. It prints a blue line which is mostly below price whenever it detects a bullish trend. On the other hand, it prints a red line mostly above price whenever it detects a bearish trend.
Trading Strategy
This trading strategy is a simple trend reversal strategy which trades on crossovers of the Trend Magic indicator line and the 50 EMA line. It is very simple and straight forward.
Traders should simply take buy trades whenever the blue Trend Magic line crosses above the 50 EMA line and sell trades whenever the red Trend Magic line crosses below the 50 EMA line. Sounds simple right?
However, not all trades should be taken blindly. Traders should read price action and check if price is making higher highs or lower lows after the crossover.
Indicators:
- Trend Magic
- 50 EMA
Preferred Time Frames: 1-hour, 4-hour and daily charts
Currency Pairs: FX majors, minors and crosses
Trading Sessions: Tokyo, London and New York sessions
Buy Trade Setup
Entry
- The Trend Magic line should change to blue.
- The Trend Magic line should cross above the 50 EMA line.
- Price should create a higher high as the Trend Magic and 50 EMA line crosses over.
- Enter a buy order on the confirmation of the conditions above.
Stop Loss
- Set the stop loss on the fractal below the entry candle.
Exit
- Close the trade as soon as the Trend Magic line changes to red.
- Close the trade as soon as a bar closes below the 50 EMA line.
Sell Trade Setup
Entry
- The Trend Magic line should change to red.
- The Trend Magic line should cross below the 50 EMA line.
- Price should create a lower low as the Trend Magic and 50 EMA line crosses over.
- Enter a sell order on the confirmation of the conditions above.
Stop Loss
- Set the stop loss on the fractal above the entry candle.
Exit
- Close the trade as soon as the Trend Magic line changes to blue.
- Close the trade as soon as a bar closes above the 50 EMA line.
Conclusion
Trend reversals are profitable strategies. However, many traders do not seem to get how to trade trend reversals effectively. They would take any crossover signal and interpret it as a trend reversal.
This strategy on the other hand confirms the trend reversal based on the definition of a price action trend. By doing so, we significantly increase the probabilities to work in our favor. Not only do we get a high yield trade setup in the form of a trend reversal, we also get a trend reversal setup that has a relatively higher probability compared to other crossover strategies.
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