Home Forex Trading Strategies Forex Basic Strategies Pairing Significant S&R Levels With RSI Indicator To Generate Accurate Trading Signals

Pairing Significant S&R Levels With RSI Indicator To Generate Accurate Trading Signals

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Introduction

In the previous set of articles, we discussed strategies based on trend continuation or trend reversal. Let us change the subject a little bit and discuss a strategy based on ‘Support and Resistance.’ Although we all know how to trade support and resistance, there is always a problem of consistency when it comes to trading using the conventional support and resistance strategy. We have a look into some of these issues by designing a strategy that provides not only decent risk-to-reward (RR) but also a high probability of success.

Markets are continually changing due to changes in market participants, global politics, and economic events. This means if we continue to trade the usual way, we could be in trouble. It is necessary that, along with markets, we, too, change our trading strategy in order to adapt to the changing market environment.

Time Frame

The strategy works well on the 1-hour, 4-hour, and ‘Daily’ time frame. Therefore, the strategy is suitable for the swing to long-term traders.

Indicators

We make use of only one technical indicator in the strategy, and that is the Relative Strength Index (RSI) with its default settings.

Currency Pairs

The strategy is suitable for trading almost all currency pairs listed on the broker’s platform. One thing we need to ensure before choosing a currency pair is that it should be volatile.

Strategy Concept

‘Cup and Handle’ is a powerful candlestick pattern that shows the prevalence of bullish strength in the market. It is a very reliable pattern that offers excellent trading opportunities. ‘Cup’ formation indicates that the price was unable to make a proper ‘lower low’ on the higher time frame due to a strong buyer who took the price up. The ‘handle’ indicates that the market was unable to reach the previous ‘low’ due to weak sellers where eventually buyers bought at a higher price and are in the process of making a new ‘higher high.’

The logic behind the formation of the ‘Cup and Handle’ pattern makes it one of the most powerful patterns. But the pattern alone is not the basis for the strategy; we also use the RSI to take the highest probability trades. We apply the concept of ‘Cup and Handle’ pattern and RSI indicator at a long-term ‘Support’ level to execute low-risk ‘long’ trades.

The same concept applies when taking ‘short’ trades at long-term ‘Resistance’ level. Here we should look for the formation of the ‘Inverse Cup and Handle’ pattern at ‘Resistance.’ ‘Cup’ here indicates that the price was unable to make a proper ‘higher high’ on the higher time frame due to strong seller who crashed the price. The ‘handle’ indicates that the market was unable to reach the previous ‘high’ due to weak buyers where eventually sellers sold at a lower price and are in the process of making a new ‘lower low.’ We use the RSI indicator to take the highest probability trades by looking for ‘overbought’ and ‘oversold’ situations in the market.

Trade Setup

In order to use the strategy, we have considered the 4-hour chart of AUD/USD, where we will be illustrating a ‘long’ trade using the rules of the strategy.

Step 1:
The first step is to identify long-term support and resistance levels. By long-term we mean, support and resistance levels on the 1-hour time frame and above. Note that the greater number of touches, the stronger is the support or resistance. We would recommend at least three touches at the support or resistance to calling it a strong one. To raise the odds in our favour, we can look for trading at support level in an uptrend and resistance in a downtrend.
The below image shows long-term support being formed in the AUD/USD pair on the 4-hour chart.

Step 2:
Once we have identified the critical technical level, we will wait for the price to present the ‘cup and Handle’ pattern at support and ‘Inverse Cup and Handle’ pattern at resistance. Here we should make sure that when the price at support, the RSI indicates an oversold (below 30) situation in the market at least once and then shows up the pattern. On the other hand, when the price is at resistance, the RSI should cross above the level of 70, indicating an overbought situation and then show up the ‘Inverse cup and handle’ pattern.

Step 3:
After ensuring that the pattern is formed at the right place along with suitable indications from the RSI, we now discuss how to enter the trade. In a ‘cup and handle’ pattern, we enter ‘long’ right at the price break out above the ‘high’ of ‘cup’ pattern. In an ‘inverse cup and handle’ pattern, we enter ‘short’ when ‘price’ breaks below the ‘low’ of the ‘cup’ pattern.
The below image shows an example of we enter for a ‘buy’ at ‘support.’

Step 4:
After entering, it is essential to determine the stop-loss and take-profit levels for the trade. One of the primary reasons behind low risk-to-reward (RR) ratio is late ‘entry.’ Stop-loss is placed below the ‘low’ of the ‘handle’ pattern in a ‘long’ position and above the ‘high’ of the ‘handle’ pattern in a ‘short’ position. The strategy essentially says to enter when prices have travelled a decent amount of distance from support or resistance, which considerably reduces the risk-to-reward (RR) ratio.
The below image shows the result of the trade executed using the above strategy where the resultant risk-to-reward (RR) of the trade is 1:1.

Strategy Roundup

Although the ‘Cup and Handle’ pattern is a bullish continuation pattern, if we understand the logic of the pattern and apply at key technical levels, it can provide excellent opportunities for short as well as long-term traders. Using the RSI indicator along with the pattern gives an extra edge to the strategy, which makes it highly suitable in changing market environment.

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