oscillator Archives - Algorithmic and Mechanical Forex Strategies

Trading with the Aroon Indicator

January 2, 2017 by Lior Alkalay Leave a Comment

Through this column we have covered many oscillators which are generally very effective in analyzing momentum; they include the Average True Range, MACD and the VIDYA. Some oscillators are better at predicting short term momentum, while some are lagging indicators and tend to shine brighter when it comes to long term momentum. Yet, in this article, I will be focusing on one oscillator—the Aroon Indicator—that has a very different benefit. As a backstory, the Aroon Indicator was developed by Dr. Tushar Chande a little more than 20 years ago. What makes the Aroon indicator special is that it provides in-depth insight as to how the buyers and the sellers are behaving within each price level. I will explain how that understanding of the buyers’ and the sellers’ behavior is very useful information.

Aroon Indicator: The Basics

The Aroon indicator, as seen in the chart below, has two separate curves, in this case marked with green and red. The green curve, called the Aroon Up, measures the buying momentum over time and the red curve, called the Aroon Down, measures the selling momentum. How does the Aroon measure momentum? In the Aroon Up it measures how much time it takes a pair to reach the highest level from the opening price at a given period. Conversely, in the Aroon Down, it measures how much time it takes the pair to reach a new low from the opening price.

In both the Aroon Up and the Aroon Down, the higher the indicator the stronger the momentum. So if the Aroon Up is high, it means buying activity is strong, and if the Aroon Down is high it means selling activity is strong. If both are high, then buying and selling activity is high, and if both are low, vice versa.

Aroon Indicator: Down to Practice

Now that we have established how to read the Aroon Up and the Aroon Down, it’s time to move into practice—how comparing the Aroon Up and the Aroon Down within the Aroon Indicator can help us understand the trend.

In the sample below we can see two zones, which I will call Zone A and Zone B. Each chart variation captures a different layer in the Aroon analysis and therefore each could provide a practical example on how to use the Aroon Indicator.

Zone A.

In Zone A, we can see that, around July(Point X) the EURUSD had just started a very strong bearish trend that subsided only in April 2015. Before the Bearish trend began, the Aroon Up was high and the Aroon Down was low. This indicates that buying activity was elevated while selling activity was low. Then in April, the Aroon Up was starting to fall and the Aroon Down jumped shortly after. What does it mean? It means a quick change of momentum because as soon as the buyers became exhausted the sellers immediately began piling in. Selling activity was high through to April 2015 while buying activity continued to fall.

Insights-

The sellers are substantially more dominant around Point X. The sellers were very quick to react, showing overwhelming conviction over the buyers around this point. Hence, it should be recognized by the trader as a substantial pivot.
Once the Aroon Down jumped it stayed at an elevated level and held almost a straight line, suggesting the selling momentum was especially strong and this means a trader could expect a strong bearish move.

Zone B.

In Zone B, we can see something interesting; while the Aroon Down fell until October 16^th, the Aroon Up was still staying low. So, while the sellers were out of the market, the buyers were not coming in, suggesting very weak buying appetite. Moreover, after October 16^th, the Aroon Up jumped and so did the Aroon Down; later, both fell and then both jumped again. That suggests that even after the nose dive the pair took, and even after some buyers came back, the buyers were hesitant to buy. Nevertheless, because the Aroon Down is also unstable it means that, at that level, the sellers were also somewhat hesitant.

Insights-

In the immediate time frame, the trader might expect the pair to trade with some sort of sideways momentum, with both the buyers and the sellers undecided.
When we look at the bigger picture and in the context of what happened before October 16^th it is clear that the sellers had the upper hand. And, even when the sellers were sitting on the fence, the buyers did not come in and even when they did they were still hesitant. This means that there is a rather high likelihood that the sellers will gradually comeback for more and that signals a high likelihood of another bearish wave once the sideways movement is over.

The Bottom Line

Of course, I always like to stress that no single indicator is perfect and the Aroon Indicator is no different in that respect. If the Aroon Indicator is not calibrated to the right duration or at other times during very high volatility the reliability of it might be lower. But, this is a very powerful Indicator, and the fact that it adds another layer to our analysis by letting us understand the behavior of both the buyers and the seller around each time frame and price zone makes it a powerful tool for those traders that focus on the long term.

Trading the Symmetrical Triangle

October 3, 2016 by Lior Alkalay 2 Comments

I always like to say, that in any trading strategy, you should only be exposed to the market when absolutely necessary. That is, whether it’s a strategy running on daily intervals or on monthly intervals, a trader should not stay in the market longer than needed because it leaves room for the unexpected. This is especially true when it comes to momentum strategies and it can be the difference between gain and pain. The Symmetrical Triangle strategy is one that is simple and effective enough to let you gain from momentum, without staying a second longer than necessary. The strategy relies on a pattern that, no surprise, is called the Symmetrical Triangle.

Symmetrical Triangle Pattern

So what is the symmetrical triangle pattern? Simply put, it is a pattern that enables you to buy into a correction and sell before the pair peaks again.

In order to identify a symmetrical triangle pattern, we have to watch for four unique yet symbiotic conditions.

The pair has to be in a long term bullish trend.
The pair has to be in the midst of a temporary correction.
The correction has to be in the shape of a triangle with lower highs.
The momentum of the correction has to converge with the oscillator, as seen in the MACD chart below.

The buy signal comes at a very specific time. That is after the pair breaks the correction pattern and oscillator (in this case, the MACD) moves back above zero and ascends into buy territory.

The symmetry of the triangle is what helps us determine our limit. The symmetry does not have to come in the shape of a symmetrical triangle on the upward move. In fact, only one element should be symmetrical—the highs. The highs from where the pair breaks the correction pattern (see point A) should be identical to the highs of the triangle.

Using the grid to measure the height, if the height of our triangle is three and a half squares we should stretch point A three and a half squares to point B.

The Idea Behind the Strategy

So what is the idea behind the Symmetrical Triangle?

To get the answer, we need to start with the end result.

The chart shows that the pair has continued above point B (which was our target), yet the symmetry rule made us exit the trade early. Why? The idea is that when you have a triangle break that fulfilled the aforementioned conditions it tends to generate a move higher, at least the same height as the triangle from the point of the break. If, for example, the bullish trend would have been over, the pair would have topped out a little above point B. But if we were targeting G, a higher point, and stayed too long, we could have ended up with pain rather than gain. But the symmetry method allows us to take a profit even if the pair was about to top out and reverse.

When we add the entry methodology that allowed us to enter the trade early with minimal risk the picture become clear. The symmetrical triangle is an “in and out quick” strategy that minimizes risk in both directions. The entry is right at the bottom of the correction and the exit point is distant enough to make it a worthwhile trade and quick enough to avoid a potential trend reversal.

Before You Start

Of course, as with any strategy, including the Symmetrical Triangle, there is no singular perfect strategy that can always guarantee profit. The major downside to the Symmetrical Triangle strategy is that the pattern does not occur every time. For example, in the waves that followed we can see there were no lower tops when the pair corrected, just a steep descent towards the support line. That means that the Symmetrical Triangle is a low frequency strategy—it provides an entry signal only every once in a while.

Naturally, that means you cannot rely on this strategy alone for profits because it may take time between each opportunity. But, when balanced with other strategies, the Symmetrical Triangle can certainly spice up your results and allow you to improve your trading performance each time it produces a burst of momentum.

Use Gann Fan with Oscillators

July 25, 2016 by Lior Alkalay Leave a Comment

Buying into a bullish trend on the dips is a popular long term strategy. You focus on the USD/JPY or any other pair that is on a long term bullish trend, wait for it to dip and jump in. You buy when the pair is low and just wait for the trend to continue.

Yet as simple as that may sound, too many traders come out bruised from buying on the dip. The dip turns deeper and deeper until it hits your stop loss and you get thrown out. And then, usually, Murphy’s Law kicks in, and shortly after the pair slices through your stop loss, lo and behold, it starts rising. The bullish trend is back, only you’re not riding it.

What you need is a way to figure out how deep the dip is so you can plan your entry and ride on the bullish trend without getting thrown out. One tactic I find to be effective is combining a Gann Fan with an Oscillator. This allows you to predict, with a greater degree of accuracy, the right time to jump in and buy on the dip.

Every Gann Fan Needs an Oscillator

The way a Gann Fan works is simple. You stretch the main Gann line as a trend line support across the trend (see illustration below) and the Gann Fan function gives you alternative trend lines above and below. The problem is that it’s hard to tell which alternative trend line will be the one to actually hold and allow the trend to continue, leaving you no better off than you were without the Gann Fan.

Nevertheless, if we combine the Gann Fan with an oscillator, the Gann Fan becomes much more accurate. Possible oscillators to use are the MACD, Stochastic Oscillator or, in our case, the Moving Average Oscillator. I find the RSI to be less effective in this case, but all those we previously mentioned and some others can work well, as long as you know how to use them.

Looking at the sample below, we can see the Gann Fan suggests three possible points for the trend to resume; A, B and C. Both A and B break and fail to hold but C holds. What makes Point C so special? Only in Point C does our Oscillator move from negative to positive, suggesting a change in momentum, and signaling that this is the true support line.

Avoid the Pitfalls

Of course, just as in every strategy, there are pitfalls that you should do your best to avoid. Here are a few tricks to avoid the most common.

Check your Gann: The first thing you’ve got to check (and recheck) is that you’ve drawn the Gann Fan main line on top of the major trend line. You must be sure to start your Gann stretch from where the trend has begun, which will help you recognize the main trend line, as illustrated in the sample below.

Don’t Use Gann for Short Term: While it’s possible to stretch a Gann Fan on short intervals of 1h or less, oscillators are much less effective at those levels. And because oscillators allow the Gann Fan to become more accurate, the lack of an oscillator makes the Gann Fan much less effective and warrants the use of a different set of strategies and tools altogether.

Beware of the Bears: One of the biggest risks of using a Gann Fan, even with oscillators, is that if the trend has changed from bullish to bearish the Gann levels won’t hold. If you failed to recognize the change in trend, a good warning sign is if the pair fails to break the fan above for 2 to 3 times. This is a sign that resistance for the pair is heavy. It could be wise to at least double check that the trend is still bullish and if you are not sure it is then it might be wise to eject and get out of the trade before it’s too late.

How to Trade the GBP after Brexit

July 12, 2016 by Lior Alkalay 2 Comments

The selloff in GBP pairs after Brexit presents a challenge for a trader. At first glance, the strategy for the key GBP pairs, mainly that of the GBP/USD and GBP/JPY, should be simple. The GBP is in vertical short, falling almost in a horizontal line; therefore, the trader should apply a vertical short strategy. But when it comes to the GBP, and for that matter, any pair trading at multi-decade lows, the game plan should be slightly different. So without further ado, here are some tips to trade the GBP after Brexit and any pair that is under its historical lows.

GBP: Two Risks

In the aftermath of the GBP Brexit meltdown, GBP pairs, such as the GBP/USD, have two major risks that we have to navigate around – direction and momentum.

Direction – Since we are talking about multi-year lows, we cannot know when the bottom will emerge, because the pair is in uncharted territory.

Momentum – Again, we have no way of knowing when the momentum will change from vertical bearish movement to a trend to a possible range bound.

So how do we handle those unknowns? We use strategies that minimize the risk from the elements.

Buy on Hammer Reversal

As we can see in the chart below, and as is common when a vertical short occurs, after the vertical short comes a brief bounce. What indicates that that bounce is coming is a hammer reversal candle. A hammer reversal candle is a candle where the middle is long and the opening price and closing price are very close. Once we get a hammer reversal candle we can expect a small bounce.

To increase our confidence in an upcoming bounce we can and should combine a MACD indicator. If the MACD indicator suggests weakening momentum, we get a confirmation. Once we get our confirmation it is a signal to buy; our limit should be set below the opening price of the first full bearish candle of the latest vertical short.

Why should we use this strategy? When we have no indication as to when the pair will bottom out, it’s hard to take a short without risking a sudden bounce back. Normally, it’s less advisable to trade but, under the current conditions, this pattern gives us a chance to reduce the risk of the unknown and minimize the time we are exposed to a choppy market.

Sell on a Major Pull Back

At some stage, every short, no matter how strong, gets a major pull back. That will be our first real opportunity for a short entry. Once we get a major reversal, and by major I mean at least 38.2% of a Fibonacci retracement, then we will get our opportunity to short. That’s because no bearish trend ends without at least two attempts at the same low. That means that, at such a stage, we are no longer in an unknown and our target is the pair’s lowest point.

It’s important to note that when a pair experiences a major retracement it usually signals the end of a vertical short movement and thus is a signal for us to stop using our hammer reversal strategy.

Our limit is now known, aka the low of the pair. And our signal to short can be varied, as in trading a short under any other circumstance. Oscillators such as the MACD, Average True Range and the Stochastic Oscillator can help us time the resumption of the bearish momentum and ride the bearish wave.

But what’s important to understand here is that after a major retracement, it’s much safer to start trading on a longer term and ride a bearish wave.

In Conclusion

Although those insights have been implemented on the latest meltdown in GBP pairs, the tactics we learned here are not only useful for the GBP but can prepare you for the next FX pair meltdown, whether it’s the Euro pairs or the Brazilian Real pairs. What those tactics teach you is how to trade a rather risky situation with plenty of uncertainty. Sure, it is still risky to trade a currency in a meltdown, but at least, with the tactics above, you can avoid the major pitfalls.

Oscillators you need to use

May 31, 2016 by Lior Alkalay 8 Comments

Oscillators, one of the most interesting groupings of technical indicators, are designed to signal overbought and oversold levels. Oscillators are a family of indices that go beyond the mathematics. They focus on one important thing and that is momentum, or more specifically changing momentum. Before we delve into which Oscillators are best to use and how, let me save you some unnecessary pain. Let me tell you first what oscillators aren’t.

How Not to use Oscillators

Some traders believe that Oscillators are some sort of magic indexes. Rest assured when I tell you they are not. Oscillators’ main use is not to tell you whether to buy or sell. Rather, they alert you to when it might be a good time to execute a buy or sell strategy. That is a very big difference. Those who attempt to use Oscillators as an ultimate buy or sell signal should be ready to learn a tough lesson. Those that will use it to fine tune their timing, however, will find Oscillators a very powerful tool.

Now that we’ve established what oscillators are good for let’s focus on which oscillators are worth your time and how to use them.

MACD Indicator

Perhaps the most widely used Oscillator in Forex, the MACD needs no special introduction. What it does need is a proper explanation of how to use it and when.

The idea of MACD is to signal your entry point when you’ve already figured out where the trend is going. It’s not going to alert you to a trend. What that means is that you first have to perform your technical analysis. Once you reach a conclusion, then you can use the MACD.

On MT4, the MACD comes with default parameters (12, 26, 9). 12 represents the fast Exponential moving average, 26 the slow exponential moving average and 9 the Simple MACD average. Usually, when you trade on a daily basis, those parameters are fine.

Now in the chart below we see two points, A and B. In point A, the histogram moved above the average and that is supposed to be a buy signal. But, technical common sense says that a pronged bearish trend cannot end abruptly without some form of double bottom. Hence, one should ignore that signal.

But in point B, that’s a different story. After a double top that hits a resistance level and hits the trend average, there’s a case for a short. But we need to know when. Notice how after the second top the histogram in the MACD falls again below the average? That’s our mark and that is how you use MACD to time your trade. Once again, the lesson here is that Oscillators are for timing, not for point to the pair’s direction.

Stochastic Oscillator

This is one of the most interesting indicators in the Oscillators family. What I like about this indicator is that it essentially gives you a 2-dimensional picture of overbought, oversold and momentum. Unlike the MACD, that’s not always accurate on overbought/oversold level.

The idea of the stochastic oscillator is twofold. First, it’s normalized from 0 to 100, anything below 20 is oversold and anything above 80 is overbought.

Second, using the convergence between the %K line and the %D line tells you something. Not only can you tell when there is an overbought/oversold level but also when the trend turns bullish or bearish. Thus it affords a 2-dimensional use of momentum. Confused? Here’s a classic example of how I would use a stochastic oscillator.

In the first part, we can see that in point C, after the pair has bottomed, the stochastic oscillator was below 20. That signaled an oversold level. We can conclude that there the pair is bottomed out, through a double bottom pattern. We can use the oversold level as enforcement but wait before dipping our toes into a buy position. Only in point D, as the blue line crosses the red line, we get our signal for entry.

However, one other thing is important to note and that is point E. In point E we get the blue line crossing the red line as it does with C. However, since the cross occurs very close to the overbought signal that should deter us from establishing it as an entry. Which means if the crossing in point D was close to the stochastic 80 level, we should have avoided entry.

Average True Range

Last but not least, one of my favorite indicators, the Average True Range or ATR for short. Unlike the other two Oscillators the ATR is useful in anticipating potential rises or falls in volatility. Also unlike the other two, there is no oversold or overbought levels. If the ATR is high it suggests volatility is high. Conversely, if the ATR is low it suggests volatility is low.

How can we use this to predict volatility? We know, of course, that volatility is cyclical. Thus we can assume that when the ATR is at record lows for a prolonged period (point F) it’s a signal that a spike in volatility is coming. And, indeed, we can see volatility did come and we got the big spike.

If we decide to use the support as an entry signal we can ATR to gauge whether there’s a chance our buy trade will have a strong momentum. If the ATR was at a record high when we decide to buy that would have been a cautionary note. Not to entry but because it signals that volatility might fall and that means momentum might have been weak. The same principle, of course, works for a sell signal.

Blockade With Polarity Oscillators

July 16, 2014 by Eddie Flower Leave a Comment

The forex blockade trading strategy is one of the simplest ways for disciplined independent traders to profit from currency price moves. It’s a great strategy for mechanical trading systems because it relies on a polarity oscillator and only a few other indicators and parameters, which can easily be programmed. It’s well suited for trading on 5-minute time frames.

Best of all, when the blockade strategy is traded in combination with the related reversal strategy, experienced traders can profit by “scalping” the polarity oscillator.

The forex blockade strategies use the twenty-day exponential moving average (20 EMA) by itself or in combination with the middle Bollinger Band, as a polarity oscillator to indicate likely test and retest price levels. Depending on the market, this combination usually provides the mechanical trading system with the most accurate assessment of forex blockade points.

Traders should also look for confirmation of signals from nearby round-number price levels, pivot points, and support and resistance.

This strategy is called a “blockade” because the 20 EMA or polarity oscillator acts as a price barrier on either side. If the price is over the EMA and staying above it, and then the price retests the EMA, it will probably bounce off and continue higher.

Likewise, if the price is under the 20 EMA and then retests it, the trading system’s bias is “short” and the price will probably reject and move lower.

Trading blockades using the polarity oscillator

A typical polarity oscillator combines the EMA and the Bollinger middle band together. On the charts accompanying this article, the 20-EMA is shown as a solid yellow line, while the combined polarity oscillator appears as yellow streaming. For example, on the chart below, the circle shows a bullish signal at the polarity oscillator.

Of course, the retest of the 20-day EMA is the meat of the signal. Using the polarity oscillator as a combined EMA-Bolly Band indicator increases reliability of the signals, and gives forex traders a clearer picture of the market.

Below are more sample charts showing the forex blockade strategy:

Changes in polarity and bias

At the far right side of the chart above, if the currency pair price convincingly closes above the 20 EMA, this means it has switched polarity and the trading system now changes to a long bias.

Going forward, the mechanical trading system will be prepared to sell when the currency price drops down and touches the 20 EMA.

When to trade the blockade

The forex blockade strategy can be applied to any currency pair. It can be traded on any of several time intervals, yet some of the most-successful blockade traders work on 5-minute time frames.

And, this strategy can be traded anytime during the trading session, but some time ranges offer more reliable trades. As an example, there may be a good breakout and retest, so the forex trader enters the trade.

Yet, the afternoon session in Asia may be very slow. Then, at the opening in London prices may be too volatile for entry. Finally, after the initial flurry of volatility from news announcements, the price may settle so that it’s once again tradable.

So, the trader must adjust the forex blockade strategy to fit each market and session.

Time of day

For best success, the forex blockade strategy should be traded during the optimal liquidity times. The time-of-day in a particular currency market is critically important: The blockade requires liquidity, so it’s best applied when the major trading centers are most active.

In Asia, the best times to trade the forex blockade are after Tokyo and Singapore begin trading currencies. And, when trading during the European session, both London and Frankfurt should be open before entering any trades.

Basic trading rules for the blockade forex strategy

• Establish trend or bias using the 20 EMA or other polarity oscillator

• When price is comfortably higher than the polarity oscillator indicator, the trend is bullish

• When price is trading lower than the indicator, then the trend is bearish

• The price tests the polarity indicator, then rejects it and moves away

• Once further confirmation is shown through nearby round-number price levels, pivot points, or support and resistance, the trade is entered

• Enter trades by using buy-stop or sell-stop orders set one or two pips in front of the price

• It’s best to set the stop-loss order above the polarity indicator for sell-stops, and below the polarity indicator for buy-stops

• Set the profit target at twice the amount at risk on the trade

• Once the price reaches a profit amount equal to the initial risk, move the trailing stop to break-even

How to quantify a successful retest?

If the currency price is over the 20 EMA it must rebound from and remain above it. And, when the price is under the EMA, it must bounce off and remain below it.

For programming mechanical forex trading systems, the signal rule is: The first candlestick to touch the 20 EMA is expected to close on whichever same side that it originally approached from.

This first candlestick is the trading signal. Once the price has rejected away from the 20 EMA, the trading system waits for a possible confirmation by the next candlestick. If the candlestick of the next time period shows a continuing move away from the 20 EMA, the trade signal is confirmed.

The more confirmations of a forex blockade, the better

The mechanical forex trading system should use multiple confirmations before entering any trade. Beyond relying on the retest and rejection at the 20 EMA to show blockade, this strategy is more reliable when several other indicators and parameters are used. These include confirmations such as nearby round-number price levels, pivot points, and support and resistance levels.

It’s important that the mechanical forex trading system never take a trade based purely on a price rejection from the 20 EMA. Ideally, nearby support and resistance levels, round-number price levels, and any other significant price point should also confirm the direction and timing of the trade.

Forex traders should also be careful to filter out the effects of pending business announcements and news. Successful forex blockade traders often decline trades within thirty or forty-five minutes before a scheduled press conference or news announcement, and wait at least fifteen minutes after the announcement before considering whether to accept trades.

Likewise, the reliability of a winning outcome is enhanced if the forex blockade trade is in the same direction as the current trend. This can be determined according to which side of the 20 EMA or polarity oscillator the currency price is currently located on.

Entry qualifications and orders

Qualifications

• The price is trending – It breaks out of a range or consolidation before the entry signal

• The price successfully retests the 20 EMA

Orders

Some forex traders divide their entries across two or more orders so they’ll have more flexibility, while others simply place a single entry order.

For long entries, using multiple entry points:

• Place 2 buy-stop orders at an entry point 2 pips above the high of the confirmation candle;

• Set orders to expire at the beginning of each new candle. So, for example, when trading based on a five-minute charting time frame, if limit orders are set they will expire at the beginning of the next five-minute candlestick unless triggered by price action during the current five-minute candlestick;

• Place the stop-loss orders 2 pips under the signal candlestick, which was the one that touched the 20-day EMA;

• The stop-loss orders can also be placed just behind a nearby swing point or support-resistance level;

• When trading multiple orders at the same entry price, set the profit target for the first order at the equivalent amount of the risk in pips. So, for example, if the forex trader’s total risk in the trade is 20 pips, the profit target for the first order is set at the same 20 pips;

• The profit target set for the second order is calculated at double the risk in pips. Continuing the above example, the profit target for a second order would be 40 pips;

For short entries, with multiple entry points:

• Place 2 sell-stop orders at an entry point 2 pips below the low of the confirmation candle;

• As with long trades, for short entries forex traders should set the sell-stop orders to expire at the beginning of each new candle;

• Place the stop-loss orders 2 pips over the signal candlestick, which was the one that touched the 20-day EMA;

• The stop-loss orders can also be placed just behind a nearby swing point or support-resistance level;

• As with long entries, profit targets are set at an amount equal to the total risk of the trade expressed in pips. So, if the forex trader’s total risk in the trade is 20 pips, the profit target for the first order is set at the same 20 pips; and, the profit target for the second order is set at double the total risk in pips;

Trailing stops to achieve profit targets

Once the currency price has moved favorably by a total amount equal to the initial risk, the first position has reached its profit target and is closed out. At the same time, the mechanical trading system changes the stop-loss order on the remaining position to the break-even level.

Continuing the same example above, once the price has moved 20 pips in the favorable direction, the first position is closed and the stop-loss on the remaining position is set at the next increment.

The remaining position’s trailing stop is left at the break-even point until the marketplace closes out the trade, either by achieving the next profit target or by triggering the stop at break-even level. Regardless of the performance of the second position, the first position’s gains are a significant prize.

Blockade reversal

The blockade reversal is a variant of the forex blockade trading strategy. It likewise uses a polarity indicator such as the EMA or a combined 20 EMA and Bollinger middle band. The variant trades currencies based on crossovers of the two indicators combined in the polarity oscillator. On the charts here, the oscillator is shown as a contracting or expanding yellow band.

In a blockade reversal, the price will stall, reverse its direction, and pass through the polarity oscillator before finally returning to retest the oscillator from the other side.

On the chart below, the Asian session (shown in blue) experienced a gradual price drop below a fairly narrow band, after failing at the day’s central pivot (the yellow line) earlier in the trading session.

The price then continued downward, slicing through the weekly pivot (the blue line) before stalling and reversing at a nearby round-number price level (the gray line).

Blockade Reversal

Next, the price moved indecisively until the end of the Asian session, when a final surge from below the polarity oscillator pushed the price toward the round-number level. This represents the level at which the 20-day EMA and Bollinger middle band would cross over.

On the chart above, the left-side circle shows a bullish entry signal. The right-side circle shows another bullish entry signal with a close above the current price range, indicated by the white line.

Differences between forex blockade and blockade reversal

The forex blockade strategy involves waiting for the trend confirmation, then trading price bounces off the polarity oscillator in the same direction as the trend.

The blockade reversal strategy comes into play once this trend finishes, and the price reverses and closes on the opposite site of the polarity oscillator.

Both of these two related strategies are traded in the same direction as the current trend, which is determined when the currency price closes on the particular side of the polarity oscillator.

Bearish Reversal

The previous example showed a forex blockade reversal traded with a bullish expectation. The above chart shows the opposite scenario – A bearish trade entered from below the polarity oscillator.

In the current example, the upward move has ended and the price has broken down and closed repeatedly under the polarity oscillator. A bearish technical signal (circled) occurred below the polarity oscillator.

Scalping the polarity oscillator

Deploying both the forex blockade and blockade reversal strategies together during the same trading session can help bring trading success during long periods of time when prices are range-bound. Savvy traders use both strategies together as an EMA-scalping strategy.

Forex blockade crossover strategies

As with the basic forex blockade strategy and the reversal variant, a variety of related blockade crossover strategy can also be developed with the power of expert advisors (EA) and mechanical trading systems programmed to watch for currency prices to break out of channels and trend strongly. Because of versatility, forex blockade trading provides a profitable opportunity to “scalp” the EMA and other polarity oscillators.

Do you use similar strategies in your own trading?

Divergence

May 31, 2012 by Shaun Overton 2 Comments

Many ideas for expert advisors and strategies utilize the concept of divergence for making trading decisions. Although the idea appears in countless indicators, divergence is most often drawn on CCI, MACD and the stochastics indicators.

Review of Divergence

Divergence occurs whenever the price and some oscillating indicator diverge in their directionality. Price can theoretically be any value between 0 and infinity. It does not have a ceiling.

Oscillators, on the other hand, are bounded by minimum and maximum values. Stochastics and the RSI range between zero and one hundred. The number fifty represents an equilibrium in the movement of prices.

When the price makes a new higher high compared to some recent high, usually around 15-20 bars in the past, the assumption is that the indicator should achieve new highs, too. What happens, however, is that as the indicator starts moving slightly in the opposite direction. The price breaks new highs. The indicator remains slight under its old high. The direction of the price movement looks sharply up, whereas the indicator reads mildly down.

Divergence is Tricky

The problem with divergence is that if you put 10 different traders in a room and ask them to draw all of the divergences that they see, you’ll get 10 different answers. Traders each have personalities, all of which vary in their sensitivity to price movements. Some look at broad trends, while others obsess over the tiniest flutter in the market. Those groups in turn draw divergences either in line with major price movements or mark the chart with constant buzzing up and down. All of this is a complicated way of saying that the period used for divergence is arbitrary.

Every thing written about divergence promises that it shows when to consider exiting a trade. My opinion is that this is probably not sound. If you think about the major legs of a trend, you can think of it like the probability of a coin toss. When the first leg of a trend starts, it has something like a 50% probability of ending. Just as with the coin toss, the fact that a coin comes up heads doesn’t change the probability of the next toss coming up heads.

If you trade the second leg of a trend, then you eliminate half of the losers that would have occurred. More persuasively, I don’t think that you can spot a trend before it occurs from any type of technical analysis. Trading the first leg is not an option if you assume that trend directionality cannot be predicted before the trend even starts.

I’m tempted to turn the idea on its head. If you define divergence with an unvarying period that is programmable, then it would be possible to analyze the probability of a trend continuing. I don’t see much validity in Elliot Wave Theory, but I do like the idea of the third leg being the biggest. Most people would count the third leg of an Elliot Wave trend as the second leg. It represents the second move in the direction of the trend.

If you used divergence as an entry method after the first leg finishes and placed a stop at the beginning of the trend, then you would expect to find a profitable strategy based on the assumptions about leg length. If the first leg is usually shorter and the second leg is usually bigger, then the winners should be bigger than the losers. The 50-50 odds of winning would still yield a slightly positive profit factor. Anything greater than 50% odds would make for a stellar expert advisor.

Kernel of Truth

What I like about divergence is its relationship to oscillating indicators. The oscillators attempt to rescale the price, which happens to match nicely with a mathematical concept called the Hurst exponent. The Hurst exponent is a number between 0 and 1 that measures the trendiness of a signal. A value of 0 implies a value that never moves, whereas a value of 1 implies a value that trends in a straight line. Financial data on sufficient time scales, usually one hour bars or longer, exhibit high Hurst values. Testing that I did on the EUR/USD daily data showed a Hurst exponent around 0.7.

The method for estimating the Hurst exponent involves rescaling the price across different lengths of time. The fact that oscillators attempt to rescale price jumped out at me. True, they do it in a much more simplistic manner. The fact that divergence, a phenomenon that occurs from rescaling, occurs when compared to the original price encourages me. It makes me wonder if there might be a kernel of mathematical truth in an otherwise subjective concept.