Damir - Trade the Momentum - Forex Trading System

Trade the Momentum

By Laurentiu Damir

Copyright 2012 Laurentiu Damir

All rights reserved. No part of this book may be reproduced or transmitted inany form or by any means, electronic or mechanical, including photocopying,recording, or any information storage and retrieval system, without priorwritten permission of the Author. Your support of authors rights isappreciated.

Table of contents

This is a simple but very efficient trading strategy thatcan make you 200 pips and more per week easily. It combines elements of marketprofile with price action setups.It is a trend following strategy thatidentifies a clear direction of a specific pair and a strong momentum and triesto capitalize using price action setups that are in line with the momentum. Itworks extremely well on the following pairs: Eur/Usd, Gbp/Usd, Eur/Jpy, Gbp/Jpy,Aud/Usd, Usd/Chf, Eur/Chf. These pairs are very liquid and at the same timethey have very good volatility. It works well also with the other liquid pairslike Usd/Jpy, Eur/Gbp, Usd/Cad but these have low volatility and I prefer notto trade them with this strategy. You will see later on why volatility isimportant. Lets get straight to the details of this trading system.

We will use the weekly candlestick chart to identifydirection and momentum of price, we will then use the 4 hours candlestick chartto identify trading setup and also the 15 minutes chart to help us enter thetrade, set a stop loss and a take profit level. Also, make sure that yourbroker charts are based on the New York closing time. If not, open a demoaccount with a broker that offers New York closing charts like Fxdd or Fxlite.

This is the most important component of the tradingsystem and it is derived from the market profile technique. Market profile is aconcept that was initially used to trade the stock market but in recent yearshas been adapted also for the 24 hour markets like the foreign exchange market.It is basically a different charting technique that can help a trader betteridentify at what level price has traded the most in a given time period and toestablish a value area for a specific stock / forex pair which is consideredto be the range where over 70% of all the trades in that specific time periodtook place. This value area acts as a very strong zone of support andresistance. Another concept of market profile is called the initial tradingrange which is the very first hour of trading of any given day. This is thestaple of the market profile chart and all those other components of it derivein one way or another from the initial trading range. This initial tradingrange is what we are interested in with this strategy and I have adapted it tothe foreign exchange market. To cut a long story short, after some time ofstudying the forex charts I have come to the conclusion that the initialtrading range in forex are the first 16 hours of the trading week. Theboundaries of these first 16 hours act as very strong support and resistancezones. Let me give you some chart examples so you can better understand what Imean.

We talked about momentum earlier and I said we will usethe weekly chart to see if there is momentum in a given pair. What I mean is wewill look for a strong directional weekly candlestick with small tail and aclose at or near the high or low. Let me show you a chart:

You can see on the chart above that all the candlespointed out are large, have very little tails/wicks and close near or at thehighest or lowest point of their range, depending of the direction of thecandle. If there is a strong bullish candle we want it to close at or near thehigh, if there is a strong bearish candle we want it to close at or near thelow. A bullish candle that closes at its high signifies that we have a cleardirection on that pair. The large size of that bullish candle means that wehave also a momentum, price is going in one direction with strong conviction, thebuyers are in complete control of the pair, and they have no problem in pushingthe price higher. When such a weekly candle forms there is a good chance thatin the following week price will trade in a small range for a short period oftime and then take off again in the direction of our large bullish candle. Thesame reasoning is valid for a strong bearish candle.

As I said before, we use the 4 hour chart to find priceaction setups after we have identified the direction and momentum on the weeklychart. The 4h candlestick chart should have period separators on it so you cansee where a week ends and the following begins. Also on the 4h chart we willplot the 200EMA(exponential moving average).You probably know that this movingaverage is the most followed by the majority of traders and as a consequence, pricevery often reacts when it is at or near the 200EMA so we will incorporate it inour trading system. Let me give examples with charts to better understand whatI mean:

Now lets see what the rules that we have to respect are whenwe find a trading setup. After the first 16 hours (the first 4 4h candles) ofthe trading week have passed we draw on the chart two horizontal lines, one atthe upper limit of the first 16 hours and the other at the lower limit. We thenwait for price to break one of these lines which means that we wait for astrong directional 4h candle that closes below or above the line like the onein the chart above. This candle should resemble the ones on the weekly chart wetalked about earlier. It should have a large body and close near the high orlow to give us the momentum we need. After this has happened we will go to the15 minutes chart to enter the trade and set stop loss and take profit levels. Wehave two very important rules that we have to take into account: the priceaction setup has to take place above or below the 200 EMA, it should notintersect in any way with the moving average. The other important rule is thatthe range formed by the first 16 hours should be at least 90-100 pips in size. Thebigger the better, remember the pairs we trade with this strategy are volatileand they usually have no problem developing an initial range of 100 pips insize. We do not trade setups smaller than this.

In the example above we have looked at the weekly chartand have seen that the trading week before this formed a strong bearish candlewith the close near the low of that trading week which gives us the directionand momentum we seek. So, in view of this we will be looking for a price actionsetup to sell this pair because according to the weekly chart we have cleardirection to the downside and we have momentum also (sellers are strong at themoment). In consequence we go the 4h chart and wait that 4 4hour candle formand draw the horizontal lines at the lower and higher limit. After price tradesin our range for a while it makes a move down to break our range but fails toclose below and retraces. The next candle though has more success and breaksour range and closes at its low as we can see on the chart pointed out with thered arrow. This is very good because it confirms what we already know from theweekly chart, that we have strong momentum to the downside. This means that wehave a setup and we go to the 15 minutes chart to enter the trade: