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Trading With the Forex Sentiment - The Momentum2 Trading Strategy

By , Quantitative Strategist
15 February 2013 12:00 GMT

In our guide to FXCM Speculative Sentiment Index-based trading strategies, we discussed the “why trade against the crowd?” with a specific look to our SSI. This article covers the “how can we trade against the crowd?” with a closer look at the Momentum2 trend trading strategy.

View how to automate the Breakout2 Trading System via our previous article and webinar recording.The Momentum2 trading system has been one of our more popular trading strategies in recent years. We need to emphasize that past performance is not indicative of future results, but the strategy has historically done well in markets with extended currency trends.

Trading Rules for the FXCM Speculative Sentiment Index-Based Momentum2 Strategy

Automate our SSI-based trading strategies via Mirror Trader free of charge

forex_trading_strategy_momentum2_dailyfx_plus_body_MirrorTrader.png, Trading With the Forex Sentiment - The Momentum2 Trading Strategy

Buy Rule: If the Speculative Sentiment Index shows that forex trading crowds are the most net-short they have been in the past 145 hours, buy one unit.

Sell Rule: If the Speculative Sentiment Index shows that forex trading crowds are the most net-long they have been in the past 145 hours, sell one unit.

Profit Targets: Momentum2 does not use fixed profit targets. Instead the system takes profits via a trailing stop loss.

Stop Losses: Calculate the Average True Range (ATR) on the past 24 daily bars. Set a trailing stop 1 ATR away from entry price. If short, this means placing a trailing stop above entry price and will move lower if and when the currency moves lower. If long, the system places the trailing stop below price and moves higher if and when the currency pair trades higher.

Reviewing and Understanding the Logic of the Momentum2 System

Entries: If SSI is most long in 145 hours, sell. If it is most short in 145 hours, buy. : This is a trend trading system that looks to take advantage of what we know about forex trading crowd behavior. Put simply: when everyone is buying or selling, it is often advantageous to go in the opposite direction.

Our data shows that the trading crowd is actually successful in most of their trades, but when unsuccessful their losses outweigh their gains. Most traders tend to buy weakness and sell strength, and this approach works well in quiet markets. In times of strong trends, however, our SSI data shows that most are unprofitable. The Momentum2 strategy looks to take advantage of this pattern and go against crowd sentiment.

Exits: Take the daily Average True Range (ATR) of the currency pair for the past 24 days. If short, place a trailing stop 1 ATR above entry price which moves lower if and when price declines. If long, place stop 1 ATR below entry price which moves higher if and when price advances.

Momentum2 uses no hard profit targets and instead relies on a trailing stop loss to ultimately take profit on its trades. Why?

The system does best during times of strong market trends. In trend trading, it is important to not limit profits when the trade is in your favor. Thus Momentum2 simply trails its stop lower or higher with strong market moves. Sample Trades from Momentum2 as shown on a EURUSD Daily Chart

forex_trading_strategy_momentum2_dailyfx_plus_body_Picture_6.png, Trading With the Forex Sentiment - The Momentum2 Trading Strategy

Strategy Tips and Resources

Not all market conditions suit the Momentum2 trading strategy, and as such there are definitely factors to keep in mind before taking any of its trade ideas. Our research on crowd behavior shows that most do poorly during times of strong market volatility.

In our Weekly Strategy Outlook report, we cover market conditions with a special focus on volatility and prices in forex options markets. We report the “Volatility Percentile” of individual currency pairs, which tells us how much options traders believe the currency pair will move as compared to the past 90 days.

Our research shows that Momentum2 tends to do better when the Volatility figure is above 25% and markets are trending. Our Forex Technical Analysis page shows a daily update of our Volatility Percentile figureas well as our Trend indicator:

forex_trading_strategy_momentum2_dailyfx_plus_body_Picture_7.png, Trading With the Forex Sentiment - The Momentum2 Trading Strategy

Past performance is not indicative of future results, but our experience shows that using the Volatility Percentile and Trend indicators helps improve performance of the Momentum2 trading system.

Automate our SSI-based trading strategies via Mirror Trader free of charge

forex_trading_strategy_momentum2_dailyfx_plus_body_MirrorTrader.png, Trading With the Forex Sentiment - The Momentum2 Trading Strategy

View Previous Articles on Automating DailyFX and DailyFX PLUS Strategies

View how to automate the Breakout2 Trading System via our previous article and webinar recording.

Automate the DailyFX Breakouts on Volatility System article, webinar.

Take advantage of forex intraday seasonality via our Asia RSI Trading system, view archived webinar.

Why do most forex traders lose? How can we avoid common mistakes?

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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15 February 2013 12:00 GMT