Trading strategy: CMO DipReturn

Description

A dip or a retracement is a counter movement within a trend. Dips can be very good entry opportunities. They offer a chance to re-enter in the direction of the trend with limited risk. The CMO DipReturn strategy detects and trades intraday dips. The strategy was developed for Forex trading in particular the EUR/USD market. CMO DipReturn can also be used for market indices and commodities.

The strategy in detail

Entry signals are given by a modified version of trader Tushar Chande’s  Momentum Oscillator. It indicates changes of direction very well and therefore is capable of showing the trader when the market comes out of a dip. The dip signals, however, require meticulous filtering. In order to filter the dip signals the strategy uses an interesting combination of a trend filter (TEMA) and a trend blocker (RAT). The strategy operates in a 5-minute time frame.

The CMO

Besides modifying trader Tushar Chande’s Momentum Oscillator we have also added overbought and oversold thresholds at +96 and -96 respectively. CMO values above or below this threshold are extreme situations. Extreme situations are potentially profitable. A return of the modified CMO below the Overbought threshold (+96) is a short sell signal. A return of the modified CMO above the Oversold threshold (-96) is a buy signal. These are the dips or retracements. Note that the long and short threshold values are identical (96). Non-identical values could lead to strategy over-optimization.

In this example a buy signal occurs when the CMO returns above the Oversold (-96) threshold.

As mentioned above the dip signals need meticulous filtering. In order to do this the CMO DipReturn strategy has both a trend filter and a trend blocker. Each of these serve a particular purpose.

The TEMA trend filter

It is necessary for this strategy to have intraday trends indicated without delay. This is achieved by the Triple Exponential Moving Average (TEMA) trend filter. This filter is a very swift and fast moving average. It is well suited to serve as a trend filter for intraday trading. Whenever the price curve is above the TEMA, the trend is upwards (bullish). This is reflected by a green chart background. Whenever the price curve is below the TEMA, the trend is downwards. This is reflected by a red chart background. A TEMA calculated over one week (1440 5-minute periods) seems to deliver the best results.

This example shows the TEMA trend filter indicating upward (green chart background) and downward (red chart background) trend zones.

The RAT blocker

The RAVEma Adaptive Trend blocker (RAT) is modified from trader-author Tushar Chande’s RAVI momentum indicator. High momentum indicates a strong trend. This strategy needs to block periods when the trend is too strong as we want to enter on dips before the strong trend continues. The RAT filter blocks out signals at times of strong trend. The parameters are classic 7 and 65 periods with a special 96 period EMA as threshold. When the RAT trend blocker is in action the background of the chart is neither green nor red.

In this example the TEMA trend filter indicates a market with a bullish trend (green chart background). However, the RAT blocker, on two separate occasions, considers the trend too strong to react to dip return signals and thus colors the chart background neutral.

When to open a position?

This strategy belongs in the category of strategies called “trend continuation”. When the trader detects a dip or retracement, for example an oversold situation within a long trend, a profit can be made by entering the market as soon as it moves out of the oversold sentiment and back into the trend.

A long position is opened when the modified CMO (6 times 5 minutes) returns above the Oversold threshold (-96). A short position is opened when the modified CMO returns below the Overbought threshold (+96).

When to close a position?

The CMO DipReturn strategy uses both a trailing stop and a profit target. Both are calculated as multiples of the Average True Range (ATR) (5 times the 24-period ATR) in order to keep into account the intrinsic volatility of the financial instrument which the trader is trading. The multiple should be adapted to volatility of the instrument traded.

Attention. This strategy uses an end of period (EOP) trailing stop. This means the market can trade outside the stop without closing the position. It is only the final price of the candle which will determine if the stop is triggered or not.

Alternatively, positions are closed when the modified CMO passes the opposite threshold. This is more frequent than a position being closed on the basis of the trailing stop or the profit target.

This example shows a quick trade on the EUR/USD future. The buysignal occurs when the CMO returns above the Oversold threshold (-96). The TEMA trend filter indicates a bullish trend and the RAT blocker considers the trend is not yet too strong. The position is closed with a profit when the CMO has been above the opposite threshold (Overbought).

This example shows a trade on the EUR/USD future. The shortsell signal occurs when the CMO returns below the Overbought threshold (+96). The TEMA trend filter indicates a bearish trend and the RAT blocker considers the trend is not yet too strong. The position is closed with a profit when the profit target (green line) is reached.

The number of dip signals generated by the CMO DipReturn strategy can vary from several per day to a few per week. The 100-day backtest looks promising.

Conclusion

The CMO DipReturn strategy generates day and swing trades. This nicely fine-tuned strategy was developed for Forex trading (EUR/USD, GBP/USD …) but can also be used for market indices and commodities (CFD of futures). Dips or retracements are not uncommon in trending markets. The art lies in only identifying the potentially profitable dips. The strategy selects dips in an intelligent and interesting way. It combines a trend filter (to indicate the main trend) and a trend blocker (to indicate if the trend is already too strong). A very interesting strategy.

Practical implementation

In NanoTrader Full follow these steps:

• Choose the instrument you wish to trade.
• Open a chart with the template study "WHS CMO DipReturn".
• Semi-automated trading? Simply activate the TradeGuard+AutoOrder or the AutoOrder function.