A new trading strategy. How do you find out the support and resistance levels as precisely as possible?
In my last educational post, I promised to teach you how to identify the trend.
There are numerous ways to do it, but one of the most common is the meeting of the moving averages.
I wanted to improve this simple method a little. Finally, it has turned out to be a complete trading strategy that suggests far more than just identifying the trend. But, first things first.
In its simplest form, the moving averages strategy looks like this:
There are two moving averages in the chart. The first one is red with a short period. As a rule, it is of 4-9 bars.
The second one is blue, with a long period (as a rule, from 14 to 25).
Therefore, when the blue line is above the red one, the local trend is bullish, and vice versa, when it is under the red line, the trend is bearish.
When the moving averages meet, it is the signal to buy or sell, according to which direction the red line crosses the blue one.
It would be perfect if it worked for any kind of trend. However, it is a purely trend indicator that sends many false signals when the price is trading flat.
There is a good example in the chart above. You see, there is a signal to buy at 11262 USD, and to sell at 9203 USD. Finally, the position lost 22%, which can hardly make anyone happy.
As I’m a Fibonacci fan, I’d like to describe an improved version of this strategy.
If you don’t remember your math lessons, I’ll remind you that Fibonacci numbers are the sequence of numbers where each next number is a sum of two previous ones.
In general, it looks like this:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, 4181, 6765, 10946, 17711…
For my upgraded strategy, I decided to apply a wider range of numbers from 13 to 1597.
Finally, I got 11 Fibonacci numbers; they are 11 moving averages with the following periods: 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, 1597.
If you place all the above numbers in the form of EMA, you’ll see a chart that looks like a web of multiple moving averages.
I should note that the price move is also displayed in the form of a line. In this case, we won’t need candlestick patterns; we are going to work only with the price levels.
As the extremes of the bars in the daily timeframe create certain key levels, it makes some sense to draw the chart exactly along the high and the low levels, to identify the support levels.
Finally, you have two charts.
On the left – there is the chart, drawn along the daily lows.
On the right – there is the chart, based on daily highs.
“What do we need it for?”, you’ll ask.
The answer is found in the basics of technical analysis.
If the trend is upward, the highs are broken through; and each next low becomes the support level.
If the trend is downward, everything is directly opposite; the lows are broken out, and the highs build new resistance levels.
Therefore, when the trend is upward, to find out the key support levels as precisely as possible, you need to look at the lows; when the trend is downward – at the highs.
Besides, the signal of the uptrend continuation is the high breakout; and for the downtrend, it is the low breakout. So, to assess the reversal signals, you need to monitor the uptrend, based on highs, and the downtrend, according to the lows.
To make it clearer for you, let’s study the example below:
In the chart, you see that dramatic BTCUSD reversal close to the level of 20 000 USD.
There was a strong signal of the bullish trend reversal in the marked segment of the chart. In candlestick analysis, this signal is not so prominent; but if you study the extremes, everything is quite clear.
You see in chart above (on the left), the lows rebounded from the support line; in addition, the highs (in the left part) broke through the support level and converged with the lows.
Besides, the uptrend principle that each new high must be higher than the previous one is violated; it is also a strong pivot signal.
In addition, the moving averages in the lows’ chart indicated strong support levels; and the average lines in highs’ chart were the strong resistance levels.
You see, the red line is below the blue one, i.e. the trend is still bearish. In this case, knowing the support/resistance levels, you can make a kind of a staircase of buy orders and a similar sell order stairs to fix the profits.
So, you put buy orders along low levels (the left part), and take profits along high levels (right part).
Finally, if you combine these two charts and remove the moving averages, you’ll see that out of three buy orders, two of them worked, and the last was at the price move low. I want to note that the profits were taken at almost the local high.
It turns out, that you buy during a dump in the bullish trend, and sell during the price retracement! In fact, it looks like QFL strategy.
Now, let’s return to the sideways trend that resulted in 22% loss, based on the trading old system.
With my upgraded strategy, the situation looks a little different.
In the left chart, there is a buy signal at the meeting point of the red and the blue moving averages.
You put buy orders at the levels, based on lows. Finally, three orders out of four worked out.
In the highs’ chart, you put take profit orders.
In the end, in the combined price chart, cleared from moving averages, this trading plan looks like this:
Finally, you’ve got quite a profitable trade with high mathematical expectation of the profit.
As you see from these two examples, this system excellently works in local sideways trends within global trends. But if the market is moving in the trend?
In this situation, I recommend opening orders in the trend during the price rebound from the short, red, moving average with a dynamic stop order (Trailing Stop) along the blue line. You take the profits either when the price reaches the key levels, or when the trend reverses (in this case, the position will be closed by trailing stop). Anyway, you will be safe from buying at the very highs. Because the range between EMA 13 and EMA 21 is very narrow, you will always have a controlled, low risk degree and avoid exiting the trade too early, before the price develops.
Besides, you must always take into account the trend direction and remember that, according to the strategy, you use moving averages drawn along the lows for an uptrend, and the ones, based on the highs, for a downtrend.
As an example, I’ll describe the situation with the bearish trend.
In the chart above, the moving averages based on lows are on the left; the ones, drawn along highs, are on the right.
You see the red line is below the blue one, so the trend is bearish, and you trade, based on the rebounds from the averages, based on highs.
In the right part of the chart, there is marked a short position at 9194 – the rebound from the red line.
In the chart of the lows’ moving averages, you mark the key resistance levels and put take profit orders at them (see the left part of the chart).
Finally, your take profits for the shorts are at 8158.98; 7293.76; 6690.40.
In addition, the trend pivot signal will be meeting of the red and the blue moving averages (see the chart below).
However, if you use trailing stop, this situation is unlikely, as you’ll take the profits far earlier, when the price breaks through the blue high-average, along which you stop was moving (see the chart below).
So, next, you expect an entry point to go long, i.e. the rebound from the red low-average.
In the chart above, you see such signal at the level of 9067.32 USD, but there wasn’t a rebound. The ticker started correction, so the trade was exited by the stop order at the blue line level, 8805.79. In the end, you got a minor loss of 3% of the position opened.
In my next post, I’ll try to combine all the systems and analyzing methodologies, I described in my recent educational blocks, into a single trading tool.
It will include the above approach that I called High Low EMA (HLEMA), the strategy of identifying the momentum, QFL strategy and some elements of SK-FX strategy.
Summing up the information about HLEMA:
Advantages of the method:
- Signals are only in the trend;
- Buying at the lows in a bullish trend and at the highs in a bearish trend;
- Controlled risk percentage;
- Ease of use (it is easy to identify entry/exit points and SL levels;
Strategy can be applied both in the directed and the sideways trends.
Drawbacks of the method:
- Stops and orders must be moved regularly, according to changes in location of the moving averages;
- To identify whether the market is trading in the trend or flat, you need additional indicators;
- The market can cover up to 50% of its move’s length before the trading signal appears.
You could try the trading strategy in demo mode here: https://my.liteforex.com/trading/chart?symbol=EURUSD&returnUrl=true
I wish you good luck and good profits!
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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.