- May 10, 2022
- Posted by: CoachShane
- Category: Trading Article
This 5X5 trading strategy can be good for short term bursts in price movement. Using the relative strength index set to 5 along with the 5 period simple moving average, combines momentum and trend for a powerful combination.
Using The RSI
The RSI will show us overbought and oversold conditions in the instrument. While not a guarantee of any price reversal, it does help to show an extension in the momentum of price. From that extension, we’d expect a reaction in the opposite direction.
When we see the RSI line dip below the 30 level, we’d consider the instrument to be oversold. We would then look for an indication of a snap back in price. Overbought level will be indicated by the RSI above the 70 level. The 50 level will be our “short to long” – “long to short” indication.
How To Use The 5 SMA
The moving average will be a trend indicator based on slope and will also be used for an entry trigger.
If we see the overall slope is down, we’d be looking to take short trades. A slope that is upwards will be giving us a long indication.
When price crosses the SMA and closes strongly, we can consider that, along with other conditions, to be a signal to place a buy or sell order.
There are so many ways to take profits and every trader will have a preference. From trailing stops to profit targets, all are a viable means of closing out your trades. For our purposes in the article, we will be considering 1R profit targets.
1R profit targets are done by taking profits that equal your risk amount.
For example, a protective stop on this example is below the setup candle for a .35 stop loss. The buy stop entry is above the high and is set at .35 profit.
Using this method of looking for 1R profit targets, while good for testing, is also good for real world trading. Adding in a buffer to to account for commissions is not a bad idea.
What Is A Buy Signal
When we are looking for a long trade, we will need to see the RSI crossing the 50 level to the upside and a strong bullish close above the 5 simple moving average. The RSI could have crossed a few bars ago but we are looking to avoid an extension in price.
We can also front run the crossing of the 50 line if the RSI is coming out of the oversold zone.
Price is coming off a downtrend and the RSI is oversold. Sharp rise in the RSI followed by a strong close above the simple moving average. Buy stop order is placed above the high of the candle and we set our stop below the low. The RSI did confirm a break of the 50 level the day after the setup.
Here is another example using a day trading time frame.
Both trades hit the 1R target after coming out of an oversold condition.
Using the weekly chart, nothing changes except a trader may look to hold the position utilizing a trailing stop feature to lock in gains. An understanding of price structure and momentum will help a trader immensely with this and any strategy.
While there were a few candles that close above the 5 SMA, you not only want to see a large percentage of the candle over the average, but also strong looking candles. Closing on or near the high is a good sign of strength and should be noted. Also keep in mind there will be zones of resistance potentially in the way of price movement. Knowing what to look for as price is near a resistance zone will help make this strategy successful.
Support Or Resistance
This is not something you’d trade automatically when a setup occurs. Remember, this is just showing us momentum is in your favor at a point in time on the chart. You still need to have even a basic understanding of reading a chart.
This chart shows an instrument heading into a rally from a down move in price. The 5 period RSI was oversold for many days and a strong momentum candle steps in breaking the 5 SMA. The setup is heading right into a level that acted as support, strongly supporting price in the past, and could act as resistance in the future.
In this example, price puts in a double bottom chart pattern and while a double bottom is not confirmed until the resistance breaks, front running a break while being mindful of risk, is a viable approach.
Note that small range candles are not always negative depending on the shape they take. The candle with the arrow has a longer lower shadow and closes .01 off it’s high. Price reaches a 1R target and then some.
Could you use the chart pattern to help with how you will take profits? If a double bottom forms, anticipating at least a challenge of the resistance zone is viable as you manage your trade. On this chart, price did break resistance, formed a trading range, and then reversed to the downside.
Trend Line Breaks
Another addition to the setup would be using a short term trend line break as confirmation. In this example, we will look at a short trade after a run up in price over 28 trading days.
Price comes from an overbought condition and breaks the 5 SMA along with the trend line. Nothing magical about a trend line but they do a great job of showing a change in the rhythm of price movement. On the left, you see another setup that gets triggered with a strong candle that also breaks resistance.
Combining a trend line with this strategy is a great technical addition as is looking for an obvious chart pattern. Profit targets are up to each trader and as you study hundreds of examples, you will find some common themes between instruments that have the potential to run.
Using this strategy in what appears to be a trend change does increase the probability of a successful outcome. A change in trend means that you are looking at an instrument that was actually trending and not rangebound.
Much like price flipping around a moving average, if the RSI is flipping above and below the 50 line, you are looking at a choppy condition and it is best to move on to cleaner charts.
Any questions or comments, please put them below. Ensure you study many examples and on the timeframes you are able to trade.