Reversal strategies are often used in strong trends when the price of an asset is moving one way in general but has particular retracements and corrections. This is why it’s extremely important to find reversal entry points as well as determine the potential depth of a by-trend bounce in order to open new trading positions or add volume. At the same time, trading systems are aimed to avoid false signals with filtering thanks to additional technical tools, which suppose to confirm or deny the signal from primary indicators. The best number of instruments used in a strategy is three as sometimes a pair of them do not give full information about the short-term momentum and direction.
Parabolic SAR is the main indicator in this trading system, and any further action or analysis is made only after it switched the sentiment. Parabolic SAR has quite a complicated mathematical formula, and it’s represented with dots on the price chart. Once dots jump above the price from being below it, then the uptrend is going to change the direction. If Parabolic dots appear below the price after showing the downtrend, then traders should consider opening long positions. A wide range of timeframes could be used with this trading strategy starting from 15-minutes charts. All assets are applicable with the only condition that a strong trend should be in place, otherwise, Parabolic SAR gives a lot of false signals due to its nature of the trend indicator. Default settings are used for all indicators here.
Stochastic oscillator perfectly complements Parabolic SAR as it gives a lot of information to analyse. Besides the main threshold of 50%, showing the trend’s direction and current momentum, Stochastic also points to oversold/overbought levels and it has two lines in contrast to Relative Strength Index, for instance. Those two lines bring additional confirmation as once they cross each other, the likelihood of reversing the current trend is getting higher. Stochastic has to point to an uptrend (the value should be above 50) once Parabolic SAR jumps below the current price before pulling the trigger. And it has to be below 50 when Parabolic SAR jumps above the current quote.
MACD is a popular trend indicator and it could be implemented as the primary tool. However, this trading system is based on Parabolic, and MACD works as a confirmative tool here. The main reversal condition for MACD happens when its lines perform a crossover, confirming the signal came from Parabolic. That’s the third and final condition before opening trading positions.
When it comes to stop-loss and take-profit orders, traders could place them before a strong psychological round-figure resistance/support levels. For example, 1.2800 for GBP/USD or 1.1400 for EUR/USD and so on. Another option of exiting the market is to get an opposite signal. However, opening positions in the opposite direction with the only Parabolic is dangerous and the conditions of three indicators pointing to a reversal should be executed before reversing. Trailing stops are possible. An example of Parabolic, Stochastic and MACD Forex Trading System in action is shown on the chart below.