The Magic Momentum Method

The Magic Momentum Method is a trading system discretionary based on RSI and Trend Lines.

The Magic Momentum indicator: RSI

We use the Relative Strength Index (RSI) momentum indicator as our prime indicator when trading the 1 Indicator Simple Way of trading the Forex Market. This indicator measures the momentum present in the market – this means that it shows who is in charge – the bulls or the bears. When the bulls are in charge the market is in a Buy phase and when the bears are in charge the market is in a Sell phase. The RSI that we use has a setting of 4. This means that the position of the indicator reading is based on the momentum information 4 candles or time frames back. If we were to increase the setting to say 14 the indicator can become very flat and difficult to read. If we decrease the setting to 2 then the indicator becomes too sensitive and the readings become meaningless. So over timIn a normal sideways market the 50 or middle line on the indicator separates the bull (Buy) area from the bear (Sell) area. Above that line is the buy area and below the line is the sell area. e a setting of 4 has served us well. We also set 3 levels on the indicator. The 25, 50 and 75 levels.  

Sometimes the bulls are so strongly in charge in an upward trending market that we credit them with more than 50% of the area. We allocate 75% of the area to them (everything above the 25% line) as they have been so dominant that the bears will take some time to recover their strength. So only when the indicator drops below the 25% line will we consider as a sell.  

Sometimes the Bears are so strongly in charge in a downward trending market that we credit them with more than 50% of the area. We allocate 75% of the area to them (everything below the 75% line) as they have been so dominant that the bulls will take some time to recover their strength. So only when the indicator goes above the 75% line will we consider as a buy.

Trend Lines

As you can see by adopting this dynamic bull and bear area approach, it keeps us “in the trend” longer and therefore creates less whipsaws (unnecessary and unprofitable buy and sell transactions). It also turns a momentum indicator which normally is best used in a sideways market, into a trending indicator at the same time.

When the indicator moves from (say) a sell area to the buy area, it is a signal that we should consider changing from a sell (if we were in one) to a buy transaction or entering a buy.

TRENDLINES The RSI indicator measures momentum which is the same as the market sentiment. However the price chart always reflects reality. So the momentum indicator on its own is not enough to be the main trigger for a transaction. It merely provides the motivation and evidence for a transaction but the main trigger to enter deals comes from the Price chart when trendlines are violated. We like to use trendline violations by the price as the main trigger to enter transactions (deals). A trendline is nothing more than joining a number of swing lows to produce a support trendline. When using swing highs in the same way it creates a resistance trendline. Trendlines can also be drawn on the RSI indicator. The bigger the angle of the trendline the more aggressive (less reliable) the trendline becomes. The purple lines below are less aggressive than the red lines which have been drawn at steeper angles. Often trendlines on the RSI warn us that we should be looking for aggressive trendlines on the price chart. 

 Our main method of entry is when the price crosses over a price trendline after being warned about it by the RSI crossing over an RSI trendline or over the buy / sell dividing line. Remember that this technique is all about making sure that you (your transaction) are facing in the right direction when a trend develops. When you are is such a trend the technique applies risk management that is aimed at ensuring that you stay in the trend on hopefully a risk free basis.

The Entry

The system basically works like this:- 1. When the RSI starts showing a move from (say) the buy area to the sell area and/or has a trendline violation, we would immediately look for 2. A trendline on the price chart which is being violated (if we have not already drawn one in). As the trendline is violated we would then enter a sell transaction. In a fast moving (volatile) market we will enter immediately. In a slow market we may wait for more confirmation by waiting for the 1 minute candle to close and a new 1 minute candle to open. Below is an example of a sell transaction.

See more examples later in the book. This system can be a continuous system in that the entry triggers can also be the exit triggers for a previous transaction. The exit trigger for one transaction can also be the entry trigger for the next transaction.

Managing and exit

Based on the 1 minute chart method we trade with a 16 pip stop loss (sometimes 14 in a nicely moving market) and no target. The stop loss should be implemented at the same time or immediately after entering. Experienced and disciplined traders can trade with a mental stop if they have confidence to do so. Sometimes deals just do not perform as expected and may not even go positive and will be stopped out at - 16 pips. If this happens we just have to wait for the next trading signal. Using this method you will find that your stop is seldom hit as you are more likely to change the direction of your trade before it reaches your 16 pips stop. The stop includes the spread so if the spread is 2.8 your effective stop is only 13.2 pips (16 pips less the spread of 2.8). Once a deal is active and going positive we manage the transaction in a number of ways depending on the trading conditions. Based on the 1 minute chart method we could use any of the techniques below.  You could close the transaction the minute you see a strong signal to trade the other way. This is a very common reason to exit at either a profit or a loss and this reason also prevents your stop loss being hit.  You could close 50% of the transaction at between +5 and +10 pips and move the stop to breakeven thereby creating a risk free deal for the remaining 50%. Hopefully you will have caught a trend and the price will continue to trade away from the entry price.  You could close 50% of the transaction at between +5 and +10 pips and move the stop to -4 or -9. This ensures a small profit if your stop is reached but gives the transaction enough room to become part of a larger trend. Hopefully you will have caught a trend and the price will continue to trade away from the entry price.  You could close the entire transaction at say +10 or +15 if that is what you would be happy with. If you have caught a trend (the price has gone +15 pips on the 1 minute chart)  You could use the RSI 75% or 25% exit method (See later in the book)  You could use the 15 Moving average crossover method (see later in the book) When trading the 1 minute chart, experiment with these exit techniques to find the conditions which make each better to use.

Alternative exit

The signals and triggers used to enter this technique are also very good exit signals. Besides being signals to exit trades they can be used to enter the next transaction too. The idea behind this technique is actually to make sure that your transaction is pointing in the right direction when a good trend occurs and to stay in the transaction as long as the trend continues. The 1 minute chart is a very sensitive chart and ideally it should best be used as an entry chart to enter longer and stronger trends. An advanced exit technique is to use a moving average crossover to exit a trade entered on the 1 minute chart. In this respect the 15 period, smoothed, moving average based on the close price can be used. This advanced exit technique will only be used once you are happy with the basic approach. The way of adjusting the bull and bear areas as discussed previously comes close to achieving the same result as using the above moving average. 

When to trade

The best times are in the first 2 to 3 hours of Major market openings - the Asian Market (9:00am Tokyo) - the European Market (7:00am GMT) - the London Market (9:00am GMT) - the New York Market ( 8:30am New York).

Summary

The technique is: Identify entry opportunities:

See a trendline violation or a 50 line violation on the RSI

Look for a corresponding trendline violation on the price chart.

Enter the deal

Exiting the deal using any of the techniques below:

1. Your stop is hit ( this is an involuntary option which should not happen that often)

2. You reverse the direction of your trade whether you are positive or negative.

3. You close 50% of your deal at +5pips and move your stop to breakeven – mainly use this in slow markets.

4. You close 50% of your deal at +5 pips and move your stop to -4 – mainly use this in fast trending markets.

5. The price moves over the 75% line on the RSI in trending markets (markets that move +15 pips on the 1 min chart) when in a sell. When in a buy, you would close your deal when it moves over the 25% line.

6. The price crosses over the 15 moving average in a trending market. Bear in mind this is a beginner technique to ensure that you have the trading skills to identify trading opportunities quickly, enter deals efficiently and make a profit. As your trading experience increases:- you can investigate and apply filters that will make the technique even better and you can move onto longer time frames – please try to do this only once you are trading the 1 minute charts profitably.  

Examples
Low range sideways day: 

In this sessions 6 profittable trades.

A 1 trade day:- Enter a 2 lot Buy on a RSI trendline and 50 line violation and a price trendline violation. Cashed in the 1st lot at +5 and moved the stop to -5. Cashed the 2nd deal in when the RSI indicator line moved over the 25 level. Result +5 +50 = +55 pips in 70 minutes. Ended the day’s trading.