Some currency traders are extremely patient and love to wait for the perfect setup, while others need to see a move happen quickly, or they will abandon their positions. These impatient souls make perfect momentum traders because they wait for the market to have enough strength to push a currency in the desired direction and piggyback on the momentum in the hope of an extension move.
However, once the move shows signs of losing strength, an impatient momentum trader will also be the first to jump ship. Therefore, a true momentum strategy needs to have solid exit rules to protect profits, while still being able to ride as much of the extension move as possible. The 5-Minute Momo strategy does just that.
- The five-minute momo strategy is designed to help forex traders play reversals and stay in the position as prices trend in a new direction.
- The strategy relies on exponential moving averages and the MACD indicator.
- As the trend is unfolding, stop-loss orders and trailing stops are used to protect profits.
- As within any system based on technical indicators, the 5-Minute Momo isn't foolproof and results will vary depending on market conditions.
What's a Momo?
The five-minute momo looks for a momentum or "momo" burst on very short-term (five-minute) charts. First, traders lay on two technical indicators that are available with many charting software packages and platforms: the 20-period exponential moving average (EMA) and moving average convergence divergence (MACD). EMA is chosen over the simple moving average because it places higher weight on recent movements, which is needed for fast momentum trades.
While a moving average is used to help determine the trend, MACD histogram, which helps us gauge momentum, is used as a second indicator. The settings for the MACD histogram are the defaults used in most charting platforms: EMA = 12, second EMA = 26, signal line EMA = 9, all using closing prices.
This strategy waits for a reversal trade but only takes advantage of the setup when momentum supports the reversal enough to create a larger extension burst. The position is exited in two separate segments; the first half helps us lock in gains and ensures that we never turn a winner into a loser and the second half lets us attempt to catch what could become a very large move with no risk because the stop has already been moved to breakeven. Here's how it works:
Rules for a Long Trade
- Look for currency pair trading below the 20-period EMA and MACD to be in negative territory.
- Wait for price to cross above the 20-period EMA, then make sure that MACD is either in the process of crossing from negative to positive or has crossed into positive territory within the last 25 minutes (five bars or less on a five-minute chart).
- Go long 10 pips above the 20-period EMA.
- For an aggressive trade, place a stop at the swing low on the five-minute chart. For a conservative trade, place a stop 20 pips below the 20-period EMA.
- Sell half of the position at entry plus the amount risked; move the stop on the second half to breakeven.
- Trail the stop by breakeven or the 20-period EMA minus 15 pips, whichever is higher.
Rules for a Short Trade
- Look for the currency pair to be trading above the 20-period EMA and MACD to be positive.
- Wait for the price to cross below the 20-period EMA; make sure that MACD is either in the process of crossing from positive to negative or crossed into negative territory no longer than five bars ago.
- Go short 10 pips below the 20-period EMA.
- For an aggressive trade, place stop at the swing high on a five-minute chart. For a conservative trade, place the stop 20 pips above 20-period EMA
- Buy back half of the position at the entry price minus the amount risked and move the stop on the second half to breakeven.
- Trail the stop by either the breakeven or 20-period EMA plus 15 pips, whichever is lower.
Our first example above is the EUR/USD on March 16, 2006, when we see the price move above the 20-period EMA as the MACD histogram crosses above the zero line. Although there were a few instances of the price attempting to move above the 20-period EMA between 1:30 p.m. and 2:00 p.m. ET, a trade was not triggered at that time because the MACD histogram was below the zero line.
We waited for the MACD histogram to cross the zero line, and when it did, the trade was triggered at 1.2044. We enter at 1.2046 + 10 pips = 1.2056 with a stop at 1.2046 - 20 pips = 1.2026. Our first target was 1.2056 + 30 pips = 1.2084. It was triggered approximately two and a half hours later. We exit half of the position and trail the remaining half by the 20-period EMA minus 15 pips. The second half is eventually closed at 1.2157 at 21:35 p.m. ET for a total profit on the trade of 65.5 pips.
The next example (above) is USD/JPY on March 21, 2006, when we see the price move above the 20-period EMA. Like in the previous EUR/USD example, there were also a few instances in which the price crossed above the 20-period EMA right before our entry point, but we did not take the trade because the MACD histogram was below the zero line.
The MACD turned first, so we waited for the price to cross the EMA by 10 pips and when it did, we entered the trade at 116.67 (EMA was at 116.57).
The math is a bit more complicated on this one. The stop is at the 20-EMA minus 20 pips or 116.57 - 20 pips = 116.37. The first target is entry plus the amount risked, or 116.67 + (116.67- 116.37) = 116.97. It gets triggered five minutes later. We exit half of the position and trail the remaining half by the 20-period EMA minus 15 pips. The second half is eventually closed at 117.07 at 18:00 p.m. ET for a total average profit on the trade of 35 pips. Although the profit was not as attractive as the first trade, the chart shows a clean and smooth move that indicates that price action conformed well to our rules.
On the short side, our first example is the NZD/USD on March 20, 2006 (shown below). We see the price cross below the 20-period EMA, but the MACD histogram is still positive, so we wait for it to cross below the zero line 25 minutes later. Our trade is then triggered at 0.6294. Like the earlier USD/JPY example, the math is a bit messy on this one because the cross of the moving average did not occur at the same time as when MACD moved below the zero line like it did in our first EUR/USD example. As a result, we enter at 0.6294.
Our stop is the 20-EMA plus 20 pips. At the time, the 20-EMA was at 0.6301, so that puts our entry at 0.6291 and our stop at 0.6301 + 20 pips = 0.6321. Our first target is the entry price minus the amount risked or 0.6291 - (0.6321- 0.6291) = 0.6261. The target is hit two hours later, and the stop on the second half is moved to breakeven. We then proceed to trail the second half of the position by the 20-period EMA plus 15 pips. The second half is then closed at 0.6262, for a total profit on the trade of 29.5 pips.
The example above is based on an opportunity that developed on March 10, 2006, in GBP/USD. In the chart below, the price crosses below the 20-period EMA and we wait for 10 minutes for the MACD histogram to move into negative territory, thereby triggering our entry order at 1.7375. Based on the rules above, as soon as the trade is triggered, we put our stop at the 20-EMA plus 20 pips or 1.7385 + 20 = 1.7405. Our first target is the entry price minus the amount risked, or 1.7375 - (1.7405 - 1.7375) = 1.7345. It gets triggered shortly thereafter.
We then proceed to trail the second half of the position by the 20-period EMA plus 15 pips. The second half of the position is eventually closed at 1.7268, for a total profit on the trade of 68.5 pips. Coincidentally enough, the trade was also closed at the exact moment when the MACD histogram flipped into positive territory.
Momo Trade Failure
As you can see, the five-minute momo trade is an extremely powerful strategy to capture momentum-based reversal moves. However, it does not always work, and it is important to explore an example of where it fails and to understand why this happens.
The final example of the five-minute momo trade is EUR/CHF on March 21, 2006. As seen above, the price crosses below the 20-period EMA, and we wait for 20 minutes for the MACD histogram to move into negative territory, putting our entry order at 1.5711. We place our stop at the 20-EMA plus 20 pips or 1.5721 + 20 = 1.5741. Our first target is the entry price minus the amount risked or 1.5711 - (1.5741-1.5711) = 1.5681. The price trades down to a low of 1.5696, which is not low enough to reach our trigger. It then proceeds to reverse course, eventually hitting our stop, causing a total trade loss of 30 pips.
Using a broker that offers charting platforms with the ability to automate entries, exits, stop-loss orders, and trailing stops is helpful when using strategies based on technical indicators.
When trading the five-minute momo strategy, the most important thing to be wary of is trading ranges that are too tight or too wide. In quiet trading hours, where the price simply fluctuates around the 20-EMA, MACD histogram may flip back and forth, causing many false signals. Alternatively, if this strategy is implemented in a currency pair with a trading range that is too wide, the stop might be hit before the target is triggered.
How Does the 5-Minute Trading Strategy Work?
This trading strategy looks for momentum bursts on short-term, 5-minute currency trading charts that a market participant can take advantage of, and then quickly exit out of when the momentum starts to wane.
Is the 5-Minute Strategy Good for Day Trading?
The 5-Minute Momo strategy is used by currency traders looking to take advantage of short changes in momentum and could therefore be employed by day traders or other short-term focused market players.
What Is Scalping in Forex Trading?
Scalping is the process of entering and exiting trades multiple times per day to make small profits. The process of scalping in foreign exchange trading involves moving in and out of foreign exchange positions frequently to make small profits. The 5-Minute Trading Strategy could be used to help execute such trades.
The Bottom Line
The 5-Minute Momo strategy allows traders to profit from short bursts of momentum in forex pairs, while also providing solid exit rules required to protect profits. The goal is to identify a reversal as it is happening, open a position, and then rely on risk management tools—like trailing stops—to profit from the move and not jump ship too soon. Like with many systems based on technical indicators, results will vary depending on market conditions.