Trend continuation strategies and momentum strategies are often the type of strategies that could allow for a mix of a decent win rate and risk-reward ratio. This is because trending markets and markets with strong momentum have a market flow with a clear general direction. Merely trading in that direction could give traders a decent win rate. Add to it the fact that trending and momentum markets can continue further for quite some time. Traders who can time trending and momentum markets well can trade with a good mix of a decent win rate and risk-reward ratio.
This trading strategy is a simple trend continuation strategy. It trades on indications of possible resumptions of momentum in the direction of the trend. Momentum could often spark longer trends. As such, it also has the potential to produce trades with decent risk-reward ratios. This strategy uses the Bollinger Bands indicator, the Heiken Ashi Smoothed indicator, and a 100-bar SMA line.
100 SMA Line
There are several ways to identify trending markets. However, the use of moving average lines could arguably be one of the simplest and most objective methods of identifying trending markets and trend direction.
Moving average lines can be very effective tools for identifying trends and trend direction. Traders simply observe where price action is about a moving average line and then confirm the trend based on how it characteristically moves. Uptrend markets generally have price action which has pivot highs and pivot lows that continue rising. As such, it often plots price action above a moving average line.
Moving average lines also tend to follow the direction of where price action generally is. As such, uptrend markets can be identified with price actions that are generally above a moving average line and a line that is sloping up. Inversely, downtrends can be identified with price action that is usually below a moving average line and a line that is sloping down.
Heiken Ashi Smoothed Indicator
“Heiken Ashi” literally means “average bars” when translated from Japanese. The Heiken Ashi Smoothed indicator is aptly named as such.
The Heiken Ashi Smoothed indicator is a trend-following indicator that uses bars to indicate the direction of the trend. It computes for the average of the open, high, and close of each candle, and then plots bars that are derived from such underlying computations.
This template of the Heiken Ashi Smoothed indicator plots green bars to indicate a bullish trend direction and blue bars to indicate a bearish trend direction.
The bars that this indicator plots have a characteristically similar degree of responsiveness to some moving average lines which are both responsive yet smoothened out.
When combined with confluences with other technical indicators, these color changes can be a very reliable trend reversal signal.
Bollinger Bands
The Bollinger Bands is a versatile technical indicator which can be used to identify volatility, trends, mean reversals, and momentum breakouts.
The Bollinger Bands plots three lines. The middle line is a Simple Moving Average (SMA) line which is usually preset as a 20 SMA line. The outer lines on the other hand are standard deviations of price movements shifted above and below the middle line usually preset at 2 standard deviations. This creates a channel-like structure that wraps around price action.
Since the middle line is a moving average line, it can be used to identify trend direction. Price action is usually on the upper half of the Bollinger Bands whenever the market is in an uptrend and on the lower half of the Bollinger Bands whenever the market is in a downtrend.
Since the outer lines are based on standard deviations, volatility can be identified based on the expansion and contraction of the outer lines. The outer lines expand whenever volatility is high and contract whenever volatility is low.
The outer lines are also usually used to identify oversold and overbought markets. Prices above the upper line are considered overbought while prices below the lower line are considered oversold. Reversal signals to develop in these areas are considered to mean reversal signals.
The same outer lines can also be used to identify momentum breakouts coming from market contractions. Momentum candles closing outside the Bollinger Bands coming from a contracted channel are indicative of a momentum breakout.
Trading Strategy
This trading strategy is a momentum breakout strategy that is biased in the direction of the mid-term trend.
The 100-bar Simple Moving Average (SMA) line is a widely used moving average line for identifying mid- to long-term trends. As such, we will use the 100 SMA line as our main trend direction filter.
The trend direction reversal is then confirmed using the Heiken Ashi Smoothed bars based on the changing of its colors.
The momentum breakout is then confirmed based on candles closing outside of the Bollinger Bands from a contracted state.
Buy Trade Setup
Entry
- Price action should be above the 100 SMA line.
- The Bollinger Bands should contract.
- The Heiken Ashi Smoothed bars should change to green.
- Open a buy order as soon as a bullish momentum candle closes above the upper line of the Bollinger Bands.
Stop Loss
- Set the stop loss on a support below the entry candle.
Exit
- Close the trade as soon as the price closes below the middle line of the Bollinger Bands.
Sell Trade Setup
Entry
- Price action should be below the 100 SMA line.
- The Bollinger Bands should contract.
- The Heiken Ashi Smoothed bars should change to blue.
- Open a sell order as soon as a bearish momentum candle closes below the lower line of the Bollinger Bands.
Stop Loss
- Set the stop loss on a resistance above the entry candle.
Exit
- Close the trade as soon as price closes above the middle line of the Bollinger Bands.
Conclusion
This trading strategy is a trend-following strategy which trades on the assumption of momentum resuming the direction of the trend using a confluence of momentum and trend reversal signals coming from the Bollinger Bands and the Heiken Ashi Smoothed indicator.
This strategy is not perfectly accurate. There will be trades that could incur a loss. However, when used in a trending market, this strategy could produce trades that could result in decent win rates and risk-reward ratios.
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