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Home / Beginners / My Favorite Indicator That Helped Me Become A Better Trader

My Favorite Indicator That Helped Me Become A Better Trader

When I started as a new trader, I quickly noticed that I am much more comfortable spotting reversals than finding conventional trend-following or range entries. However, I was still losing money and I blew a couple of trading accounts and a few thousand Dollars before I seriously started looking into why I was failing.

Once I started auditing my trades and performance, I saw that I made some pretty good trade calls but then I always kept repeating the same mistakes and I gave back my profits and then some. However, my findings during my performance audit were liberating because I saw that my mistakes were following the same patterns and although I was still a very rookie trader, I knew from the books that I had read that those seemed to be common problems. Let me briefly sum up my problems and mistakes back then and I am sure that many of you will find yourself here too:

  • I was looking for reversals, but I was often in the ‘predicting’ mode where I went short although price was still going up and I was trying to call tops before any real sign was given.
  • This then lead to me adding to a loser because I was so sure (read: hoping), that price would turn and I was misinterpreting the quality of a setup. I lost more than one account with averaging losers…
  • I was generally a victim of FOMO (Fear of missing out) and I was often way too early in the trade where I should have just waited one more candle.
  • I entered trades out of boredom when I was forcing a trade where there was none.
  • I often went for the home run instead of closing an already profitable trade, and then my winners turned into losses.

Somewhere around that time I read the trading book “Pit Bull: Lessons from Wall Street’s Champion Trader” from Marty Schwarz and it was the right book at the right time. He mentioned that he was using moving averages as a directional filter and he also talked about utilizing checklists. I had heard this all before but now after my performance audit it made much more sense and I thought that if a ‘market wizard’ was using such simple tools like a checklist and a regular moving average, maybe it would also work for me.

I then went back to the drawing board and started applying different types of moving averages and I went from faster EMAs, to very long term moving averages, until I found my perfect fit. My fastidious record keeping showed that the 20 SMA worked perfectly – it gave the best signals and it kept me out of many losing trades at the same time.

I know, you were probably hoping for something more drastic and spectacular but you have probably heard that ‘keeping it simple’ is the way to go. And this is so true! So let me explain why I give the 20 SMA so much credit, how it helped me turn my trading around and how I use it. Today, my complete trading strategy and my whole approach is tailored around the 20 SMA.

 

No more predicting and calling tops

I only take trades into the direction of the 20 SMA. This means that I only take short trades when price breaks (and closes!!!) below the 20 SMA and I only consider long trades when price breaks above the 20 SMA.

I usually start watching Forex pairs for potential reversals when they are trending very strongly and it’s tempting to enter a reversal trade too early because you want to get in at the best possible price. The 20 SMA rule keeps me out of such trades because once price breaks the 20 SMA, price has already reversed from the absolute top.

Tip: When using the 20 SMA rule, only make trading decisions when the candle has closed. Avoid making mid-candle decisions because price often shows a fake break attempt at the 20 SMA during the duration of a candle.

 

 

The best entry for safe trades with the momentum

Once you start following rule #1, you can often catch great entries. If, after a rally, price starts reversing and then breaks the 20 SMA with a strong candle, you are often very early during a completely new trend.

Here it is important to think a little outside the box: there is nothing magic about the 20 SMA and it’s a pure filter-tool. Thus, we don’t look for candles that just barely break the 20 SMA, but we want strong ‘momentum candles’ that show that price is shifting from one trending phase into a new one.

Watch: What are momentum candles and how to use them

 

Better market selection

At the beginning, I made the mistake that I was only following a fixed selection of 3/4 Forex pairs day in and day out. As a swing trader, this is the worst thing you can do because you end up forcing trades during market periods that don’t suit your trading style.

As a reversal swing trader, I should only be trading Forex pairs that are in a strong trend with high momentum and that show early signs of fading momentum. The 20 SMA is also the ultimate tool here: when I select my Forex pairs for the trading week ahead, I only look at Forex pairs that have been moving above or below the 20 SMA for quite some time and that haven’t broken the 20 SMA recently. Also, you only want Forex pairs that show a 20 SMA with a steep angle. This alone already eliminates all low-momentum and range-bound markets that don’t go well with reversal trading.

watchlist_2_screening

Read: How I create my weekly watchlist

 

I regained my trust and abandoned FOMO

FOMOVery quickly after I established the 20 SMA rule in my trading, I saw a major improvement in my trading. Granted, this rule alone didn’t make me a profitable trader, but I saw the huge improvement in my performance and it gave my confidence in my system.

In hindsight, I can see that this is a very overlooked aspect of profitable trading. Everyone is hoping for a trading strategy that gives them consistent results while they jump from one method to the next, adjust indicators and settings, change entry rules or take completely random trades. Inconsistent trading decisions ALWAYS lead to inconsistent trading results which then leads to more inconsistent trading behavior.

Once I started using the 20 SMA and I saw the change in my trading, I gained trust and my trading decisions became more consistent which then lead to more consistent results. When I go through my trading journal, I can see that my trades now almost look IDENTICAL and whenever I see a trade that looks different, I immediately know that I screwed up. Strive for consistency in decision making!

 

 

The checklist for fool-proof trading

ChecklistWe humans are experts at fooling ourselves; we usually always know what the right thing to do is but we still come up with excuses or reasons why it’s better for us to do the opposite. Whether it’s about diet, exercise, studying, staying sober, or trading.

Early on, I always caught myself second-guessing the 20 SMA rule and I still went before the candle close or ahead of the 20 SMA because I thought I was going to miss the move or I could get more money. Well, we all know how this ends 😉

In his book, Marty Schwartz said that he was still using (after decades of making millions as a trader!!!) a laminated checklist before every trade. I didn’t have any alternatives and I had nothing to lose so I started utilizing the checklist tip as well and I created a checklist before every single trade with the signals I needed and things that needed to happen before I was allowed to enter a trade. It might sound silly but it’s much harder to break your rules if you see it black on white that what you are doing is wrong and when you have to actively convince yourself that not listening to your checklist is the right to do.

 

 

I am still not perfect and sometimes I mess up, but those unnecessary mistakes have become less and I attribute a big part of my improvement to those 2 simple hacks.

I am not saying that the 20 SMA rule is ideal for everyone and I know that it won’t work for all types of trading systems, but if you can find out what your greatest problems are and what is at the root of those issues, I am sure you can come up with ways to improve the quality of your trading as well.

28 comments

  1. As always – Great Article and it really is a Simple Technique which I have on every chart – the 20SMA.
    I will now add the Bollinger Bands for sure as I have not used them in awhile!

    Thanks Rolf and Keep well – Doug.

  2. Another excellent, and very helpful article, thanks Rolf. I really enjoy reading your articles and watching your videos because you are able to keep things very simple and explain the concepts so clearly. You acknowledge that your systems may not work for everyone, but the process you follow to find your own system is, I am sure, a valuable lesson for any trader.

    Well done again!

    • Thank you, Andy.
      I really appreciate your comment and you have perfectly described my intention behind this article. The path might be a different one, but all traders go through the same struggles.
      All the best
      Rolf

  3. What intervals are you watching when using 20SMA?

  4. Will the 20 sma work on trending markets because I am basically a trend trader, I follow the trend.

    • Jones, it sure will. Often, reversals turn into new trends and you can see that the 20 SMA is often being respected during trending moves as well.
      However, this article isn’t about whether the 20 SMA will ‘work’ or not, but how you choose your tools to overcome your struggles and improve the quality of your trading.

      Rolf

  5. Thanks for this. On which timeframe is the 20 SMA most effective?

  6. Rolf

    Excellent article, i am one of the many who suffers from FOMO, hopefully this SMA should guide me in the right direction. Can you confirm what your exit point is in this Strategy?

    Thanks

    • Hello Tahir,

      thanks. My exits are discretionary and it’s hard to put into words. You can review my Saturday recaps and see how I manage my trades. Also, I have a few step by step videos for my Saturday recaps in my YouTube channel.

      Rolf

  7. Hey Rolf,

    Awesome article as always. I really appreciate showing the checklist because as soon as you mentioned it I wondered what would go on the checklist. I’ve been trading a while and have some hit and misses more misses than hits for sure lol but thanks again

  8. Totally agree with the 20 Sma but i can see you are not drawing S&R lines…which are one of the most important thing in trading. So may i know why ?

  9. Great article. Thanks again for the distrubution! In this context I would like to ask you regarding your experience for hidden (reverse) divergences – as a trend continuation signal. What is here the success ratio in your perspective? Would not this be an easier trade as e.g. the entry point is more clearly compared to a reversal trade with a regular divergence? Maybe if you’ve confluence with support respectively fib measurement this could be especially for new traders an easier process. What do you think here? It would be nice if you can provide here some clues about this topic 🙂 Thank you.

  10. Hello..in your recent video you mentioned you used 120 SMA on H4 to represent daily 20 SMA..do you know the setting on H1 to represent H4 20 SMA?tq

  11. Thank you Rolf. I love the simplicity of your presentation with very key points covered clearly.

  12. Rule #3 of your checklist reads: “The trade is in direction of the trend”. Does it not come in contradiction with the very concept of reversal trading?!

    Anyway, keep up the great work and best wishes for 2017 😉

    • That’s the whole point.
      Most people go broke tradign reversals because they try to predict a reversal before it happens. We enter at a later stage, once a turnaround has already be confirmed.

      Regards
      Rolf

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