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Currency traders can be divided into two types – those who like to wait for the most viable setup and those who like to move in and out of positions quickly. If you fall into the second category, you are likely to rely on price momentum to place trades. For this, the 1-minute, 5-minute, and 15-minute charts will work the best. Today, we take a look at the 5-minute charts and the advanced forex trading strategy that works best with this timeframe. This is a momentum strategy, called the Momo strategy (after ‘momentum’), and relies on the Exponential Moving Average (EMA) and Moving Average Convergence/Divergence (MACD).
The momentum reversal strategy or Momo strategy identifies strong momentum changes on price charts to signal potential reversals. The aim is to determine strong price momentum that is likely to support a reversal and an ensuing price explosion.
The strategy uses the EMA, instead of relying on the Simple Moving Average (SMA), since EMA is more price-sensitive. A 20-period EMA is widely used on 5-minute charts due to its high responsiveness to the most recent price changes, which is crucial for rapid momentum-based advanced forex trading.
The MACD is based on EMA and typically consists of two lines and a histogram. For Momo, the histogram is usually applied to the 5-minute chart using the fast 12-period EMA, the slow 26-period EMA, and a 9-period signal line, all based on closing prices. The zero line that runs horizontally at the center of the histogram is also considered while identifying buy and sell signals.
The 12-day EMA is impacted by short-term price fluctuations, which are evened out over a longer timeframe, such as the 26-period line. So, the MACD can be bullish or bearish, depending on the position of the 12-day versus the 26-day EMAs. When the 12-day EMA is above the 26-day EMA, the MACD is positive, indicating bullish momentum in price, while the 26-day line cutting above the 12-day one is taken as a bearish signal.
Some traders might use the 24-, 52-, and 18-period settings for the Momo strategy. However, the default setting for the 5-minute chart is 12-, 26-, and 9-period.
When the price breaks out above the EMA lines while the MACD either remains above the zero line for 25 minutes or crosses this line from below, it is taken as a signal to enter a long position.
When a price crosses the 20-period EMA from above to below, and the MACD stays below the zero line for 25 minutes or breaks below it, it is considered a signal to enter a short position.
For long positions, a stop-loss for half the position can be placed at a price swing, before it breaks above the moving average. Another stop loss could be placed for the remainder of the position 10 pips lower than the moving average level at the point of entry. If the first half gets closed, you can adjust the other stop-loss to trail 5 pips below the take-profit level of the first half of the position.
For sell-side positions, the stop loss for half the trade can again be at a price swing, before it breaks above the moving average line. Another stop loss can be placed for the second half of the trade at 10 pips above the moving average level at entry. Just like for a long position, the second stop loss can be adjusted if the first one is hit at 5 pips above the take-profit level of the first half of the position.
A trailing take-profit level can be set with the Momo advanced forex trading strategy. Similar to the stop loss strategy, the take profit level for half the position can be set at:
Take Profit for Long Trades = Point of Entry + (Entry Point – Stop Loss Level)
Take Profit for Short Trades = Point of Entry – (Entry Point – Stop Loss Level)
For the other half of the position, the take profit could be placed at the level where the MACD breaks below the zero line for a long position and when it breaks above the zero line for a short position.
Using 5-minute charts to execute the Momo strategy allows you to capitalise on short momentum bursts in forex pairs, while ensuring robust exit rules to minimise losses. The aim here is to identify a price reversal as it is occurring to open a trade and then use risk management tools to exit the trade. This keeps emotions out of decision-making and prevents trading out of fear or greed.
This is based on the timeframe you choose for your trading strategy. For instance, a day trader might use a 15-minute chart before moving on to a 4-hour chart to confirm signals. However, a swing trader might prefer 4-hour and daily charts. Longer-term strategies, such as position trading, are based on weekly or monthly charts to discover broader market trends.
Charts with longer timeframes tend to be more dependable because they weed out false signals and the impact of short-term price fluctuations. Even with short-term trading strategies, such as scalping and day trading, including the Momo strategy, longer-term charts can be used to confirm signals.
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