Trading strategy: Break-out Big Candle

Description

The Break-out Big Candle trading strategy is based on significant changes in volatility. The strategy compares the size of the market’s current movement with the market’s recent average true range (ATR).

The strategy in detail

Break-out strategies are popular with traders because the market develops significant momentum in a particular direction. The complexity with break-out strategies is twofold. Firstly, how does the trader establish there is really a break-out? Secondly, how does the trader determine the direction of the break-out as break-outs usually occur when the market has been moving sideways? The BO Big Candle strategy offers good solutions to the above questions.

In order to define a break-out the strategy in essence relies on a pattern of two candles. Contrary to the norm the candles are not selected on the basis of their visual appearance; instead their size is calculated and compared to the recent ATR. To be precise:

- The first candle in the pattern must be a "big" candle. The criterion for a "big" candle is "The absolute value of the open price minus the close price must be > than 1,75 x the 24-period ATR".

- If the first candle is a bullish candle the high of the second candle has to be higher than the high of the first candle. If the first candle is a bearish candle the low of the second candle needs to be lower than the low of the first candle.

Note: when NanoTrader Full identifies a "big" candle it will be highlighted in the chart. A green background for a bullish candle and a red background for a bearish candle.

This example shows a "big" bearish candle. The background of this candle is red. Big+bearish implies that the absolute value of the open price minus the close price is bigger than 1,75 x the 24-period ATR. The low of the following candle is lower than the low of the big candle, completing the pattern.

The BO Big Candle strategy, however, does not solely rely on this candlestick pattern. Like any well-reasoned strategy the candlestick pattern is simply the basis. Besides the candlestick pattern the strategy includes several signals filters and two stop loss order types (see below).

The BO Big Candle strategy is applied on a 10-minute chart.

When to open a position?

The signals provided by the big candle pattern are subjected to two signal filters: an Exponential Moving Average (EMA) and a High-Low channel. Both are calculated over 6 periods (6 x 10’ = 1 hour). The EMA is visible in the chart as a green line. The High-Low channel is visible as a channel.

If the market price is above the EMA line the trend is positive. If the market price is below the EMA line the trend is negative. The High-Low channel is positive if the price closes above the channel. The High-Low channel is negative if the price closes below the channel. When both filters are positive the background of the chart is green and only buy signals are accepted. When both filters are negative the background of the chart is red and only short sell signals are accepted.

In addition the strategy uses a time filter. This time filter blocks all signals which occur before 8 AM or after 8:59 PM.

When to close a position?

The BO Big Candle strategy combines 2 stop types and a profit target. The two stop types are the Periods High Low stop and the Time stop.

• The Periods High Low stop is calculated over the last 6 periods. This stop takes the lowest point over the last 6 periods as the stop for a long position and the highest point over the last 6 periods as the stop for a short sell position. Each time a candle is added the oldest candle is dropped from the calculation and the stop is adjusted if required.
• The Time stop will close the position after 6 periods (1 hour).
• The profit target is set to 75% of the size (body) of the previous "big" candle.

This example shows a buy signal after a bullish big candle pattern. Both the signal filters are positive as indicated by the green background in the chart. The market reached the profit target 50 minutes later and the position was closed with a profit.

This example shows a short sell signal after a bearish big candle pattern. Both the signal filters are negative as indicated by the red background in the chart. The market moved up instead of down. The position was automatically closed with a small loss by the time stop after 1 hour.

This example shows a buy signal after a bullish big candle pattern. Both the signal filters are positive as indicated by the green background in the chart. The market moved down instead of up. The market price hit the period high low stop which had slowly moved up. The position was closed with a loss.

The following screenshots show long term back-tests for several market indices as well as the EUR/USD. The percentage of winning trades is around 56% for all these instruments.

The results on the German market index DAX 30.

The results on the French market index CAC 40.

The results on the U.S. market index Dow Jones.

The results on the pan-European market index Eurostoxx 50.

The results on the EUR/USD forex pair.

Conclusion

The Break-out Big Candle strategy is a finely tuned break-out strategy. In order to generate a signal the market must make a strong move outside its recent average true range. The signals they are subjected to three quality filters. Once a position is open it is managed by using two different stop types and a profit target. 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 BO Big Candle".
• Semi-automated trading? Simply activate the TradeGuard+AutoOrder or the AutoOrder function.