Flat Line Forex Trading Strategy

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Flat Line Forex Trading Strategy

“The trend is your friend!” We often hear this trite adage among traders. But is this really true?

These words of wisdom do hold some truth in it. Trading is simply much easier whenever the market is in a trending market environment. It is easier to pinpoint the direction to take that has a greater chance of success. It allows traders to have the most bang for the buck when it comes to risks versus rewards. It allows for profitable trades to run. It simply is better to be in a trending market environment.

However, there is only one thing that goes against it, but it is a very big deal – STATISTICS. The same traders who profess that “the trend is your friend”, also know that the market trends only 20% of the time. That is a very bad statistic going against trend trading. Even smart gamblers know it is better to wager on the odds with the 60% chance rather than the 40%. So, is the trend now really your friend? I guess its more like, “The trend is your friend when you can find him,” or “…when he is around.” But, most of the time he isn’t.

So, it might be better to learn to live and befriend the other 80%. What does the market do when it is not trending? What does the market do 80% of the time? It chops around.

Mean Reversion – The Only Way to Make Money on Choppy Market

Trading strategies could be categorized in two, momentum trading strategies and mean reversion strategies. During a choppy market condition, it would make no sense trading a trend following strategy, which is some form of momentum trading. Instead, we would have to take another approach – Mean Reversions.

Mean reversion is the concept that price would always go back to its average price. More like gravity pulling price back to itself. When price has jumped high enough, it would reach a peak and go back to the mean. What comes up will always come down.

Trading Strategy Concept

This trading strategy is a form of mean reversion trading that has three components.

First, we would have to know what is the mean or the average. There might be no other simpler way to identify the mean than a Simple Moving Average (SMA). For this strategy, we will be using the 50-period SMA. We will use it to identify if the market has a tendency to trend or is flat. What we are looking for is a relatively flat 50 SMA. We would also be using it as a target, knowing that price would always come back to the mean.

Then, we would have to know if price has jumped high enough. The best way to do this is to use some form of bounded oscillator with a clearly defined overbought and oversold level. For this, we will be using a Stochastic Oscillator, and will be looking for extremes as price pulls away from the 50 SMA.

Lastly, we would need to have an idea if price is showing signs that it has reached its peak and might be starting to go back to the 50 SMA. To do this, we will have to identify candles with long wicks. Wicks are signs of price rejection. It is formed because the market has quickly reversed its sentiment in a very short time, in one candle. Candles with long wicks are good, but it would be better to have a proper pin bar candle. This will be our entry signal.

Indicators:

  • 50-period SMA (Gold)
  • Stochastic Oscillator
    • %K: 13
    • %D:5
    • Slowing: 5

Currency Pair: any

Timeframe: any

Trading Session: any

Buy (Long) Trade Setup Rules

Entry

  • The 50 SMA must be relatively flat
  • Price must be below the 50 SMA
  • Stochastic Oscillators must be below the oversold level
  • Enter a buy market order on a candle that has a long wick at the bottom that corresponds with the above rules

Stop Loss

  • Set the stop loss a few pips below the low of the candle

Exit/Take Profit

  • Option 1: Close the trade as price crosses over the 50 SMA

Option 2: Close the trade at the close of the first bearish candle above the 50 SMA

Sell (Short) Trade Setup Rules

Entry

  • The 50 SMA must be relatively flat
  • Price must be above the 50 SMA
  • Stochastic Oscillators must be above the overbought level
  • Enter a sell market order on a candle that has a long wick above it that corresponds with the above rules

Stop Loss

  • Set the stop loss a few pips above the high of the candle

Exit/Take Profit

  • Option 1: Close the trade as price crosses over the 50 SMA
  • Option 2: Close the trade at the close of the first bullish candle below the 50 SMA

Conclusion

In my opinion, traders should have two strategies available. One for a trending market and another for a choppy or ranging market. This strategy could be your weapon for choppy markets.

It is not a great reward-risk ratio type of strategy as most ranging and mean reversal strategies are. But it is one that you could use most of the time.

Given that the stop loss is based on the wicks and the exit is based on the 50 SMA, avoid trades that has more risk on the pips on the stop loss than probable profits based on the space between the entry and the 50 SMA. It should at least be 1:1 reward-risk ratio.

The second exit option, exiting on a probable reversal could also increase the reward-risk ratio, or you could also try some sort of trailing stop loss.

This strategy is a working mean reversion strategy even without the stochastic oscillator, as long as you are good at identifying probable reversals. It is not perfect, but it does work.

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