Momentum Pop Scalping Forex Trading Strategy

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Momentum Pop Scalping Forex Trading Strategy

Momentum trades are one of the easiest types of trading. Yet it is also probably the riskiest.

It is easy in the sense that a trader could easily identify a momentum candle and trade it. The concept is basically to spot a momentum candle, then ride the continuation on the next candle.

However, unfiltered momentum trading is very risky. This is because trading momentum candles could also mean running the risk of chasing price. The forex market is very notorious for whipsaws causing momentum traders to buy at the peak or sell at the bottom.

Although momentum trading is very risky, there are ways to slightly increase the odds of the trade on our favor. This is by understanding what how the market behaves and how momentum candles take part in the overall behavior of the market.

The market cycles in a chaotic manner, yet through this chaos, there are certain repetitive patterns that occur. One of which is how the market moves in contractions and expansions. Contractions are phases in the market when price moves rather timidly in a tight range. This could occur for several candles. But these contraction phases don’t last. You might have heard of the phrase, “calm after the storm”? Here, the opposite is true. The market seems to have “storms after the calm”. Right after the timid price movements on the contraction phase, a wild rapid price expansion usually occurs. These are called expansion phases. These expansion phases could occur in several manners. It could be a gradual increase in strength, which could be observed at the start of many trending markets, or it could be a sudden pop signaling the start of the expansion phase. These sudden pops are called momentum candles. Full bodied big engulfing candles that dwarf the preceding candle by more than twice the size. This means a higher probability trading opportunity.

The Setup: Momentum Pop Scalping Strategy

With this strategy, we will try to filter out momentum candles as much as possible. For this reason, we will be using several indicators. First, we will be having a 5-period Simple Moving Average (SMA). This would serve as our trade direction indicator and filter for momentum candle size. Another very important indicator would be the Average True Range (ATR). This will serve as the measuring stick for our acceptable candle size.

To use the two indicators in tandem, we will have to calculate the distance of the price on the momentum candle’s close and the 5 SMA. This distance in pips should be greater than 1x the current ATR. If so, then the momentum going towards the direction where the 5 SMA is pointing will be considered strong enough.

Another filter would be that the momentum candle should be more than twice the size of the previous candle. Candlestick pattern traders might consider this as an engulfing pattern.

For good measure, we will also use the Relative Strength Indicator to indicate our trade direction. If the RSI is above 50, then our direction should be up, if below 50, then we go down.

But of course, all these rules would mean nothing without context. We should identify that all these things should occur right after a contraction phase. What we are looking for is for a momentum candle to pop out of the contraction phase.

Timeframe: 5-minute chart

Buy Entry:

  • RSI should be above 50
  • Price should be above the 5 SMA
  • Distance of price and 5 SMA should be more than 1x the ATR
  • Momentum candle should be more than 2x the size of the previous candle
  • A contraction phase should be identifiable prior to the momentum candle
  • Enter a buy market order on candle close

Stop Loss: Set the stop loss at 1x the ATR below the entry price

Take Profit: Set the take profit at 2x the ATR above the entry price

Sell Entry:

  • RSI should be below 50
  • Price should be below the 5 SMA
  • Distance of price and 5 SMA should be more than 1x the ATR
  • Momentum candle should be more than 2x the size of the previous candle
  • A contraction phase should be identifiable prior to the momentum candle
  • Enter a sell market order on candle close

Stop Loss: Set the stop loss at 1x the ATR above the entry price

Take Profit: Set the take profit at 2x the ATR below the entry price

Conclusion

If you would notice, both examples are types of contraction. The first example is a narrow range where price bounces up and down. The second example is that of a spinning top structure where price rejects a price level above and below, which signifies market indecisiveness. Understanding contraction phases are key to this strategy.

As with most momentum-based strategies that has a one momentum candle signal, this strategy is quite risky. In fact, if the context of contraction is removed, this strategy would probably not have a high probability. By using our understanding of the contraction and expansion phases of the market, we increase our chances of a successful trade

Also, by using the ATR, as our stop loss and take profit, we are logically telling ourselves that since this is a momentum candle, if price reverses on our entry by more than the usual candle size, then our momentum candle has failed. We are also rationalizing that since this is a momentum candle, the momentum should continue for more than twice the usual candle size. This also allows us to fix our reward-risk ratio at 2:1.

As long as we understand the context of the market, and we are able to identify it as a market contraction, this strategy could yield high probability trades.

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