Veteran forex trader Boris Schlossberg of BKForex.com profiles the "turn trade," a set-up that relies on multiple time frames, moving averages, and Bollinger bands that allows traders to buy low and sell high while still following the market's trend.
Most traders have an extremely hard time trading with the trend. This observation may seem counterintuitive, as the majority of traders claim that trend trading is their preferred approach to the market.
However, after analyzing the records of thousands of retail traders, we are convinced that the opposite is true. While everyone pays lip service to the idiom "The trend is your friend," in reality, most traders love to pick tops and bottoms and constantly fade, rather than trade with the trend.
In this article, we'll cover the "turn trade," a set-up that allows traders to "have their cake and eat it too" by buying low and selling high while still trading with the trend.
Turn Trade Basics
The turn trade recognizes most traders' desire to find turns in the price action (that is to buy low and sell high), but it does so in the overarching framework of trading with the trend. The set-up uses multiple time frames, moving averages, and Bollinger bands as its tools of entry.
Getting Started
We begin by looking at the daily charts to ascertain whether a pair is in a trend, and use a 20-period daily simple moving average (SMA) to determine the trend.
In technical analysis, there are a number of tools that can help us diagnose trend, but none is as simple and effective as the 20-period SMA. It includes a full month's worth of data (20 business days) and as such, it provides us with a very good idea of an average price.
Therefore, if price action is above the "average" price, we assume the pair is in an uptrend and vice versa.
Next, we move to the hourly charts to pinpoint our entries. In the turn to trend set-up, we will only trade in the direction of the trend by buying highly oversold prices in an uptrend and selling highly overbought prices in a downtrend.
How will we determine our overbought and oversold extremes? The answer is by using Bollinger bands to help us gauge the price action.
Bollinger bands measure price extremes by calculating the standard deviation of price from its 20-period moving average. In the case of hourly charts, we will use Bollinger bands with three standard deviations (3SD) and Bollinger bands with two standard deviations (2SD) to create a set of Bollinger band channels.
(Create custom forex charts using Bollinger bands for free here.)
When price trades in a trend channel, most of the price action will be contained within the Bollinger bands of 2SD and 1SD.
Why do we use the 3SD and 2SD settings in this particular set-up? Because the Bollinger band rule applies to price action on the daily scale.
In order to properly trade the hourly charts, which are more short term, and therefore, more volatile, we need to accommodate those extremes in order to generate the most accurate signals possible.
In fact, a good rule of thumb to remember is that traders should increase their Bollinger band values with every decrease in time frame. So, for example, with five-minute charts, traders may want to use Bollinger bands with settings of 3.5SD or even 4SD to focus on only the most oversold or overbought conditions.
Moving back to our set-up, after having established the direction of the trend, we now observe the price action on the hourly charts.
If price is in an uptrend on the dailies, we watch the hourlies for a turn back to the trend. If price continues to trade between the 3SD and 2SD lower Bollinger bands, we stay away, as it indicates a strong downward momentum.
The beauty of this set-up is that it prevents us from guessing the turn prematurely by forcing us to wait until the price action confirms a swing bottom or a swing top.
NEXT PAGE: See Rules for Trading This Set-up Both Long and Short
|pagebreak|In our example, if the price trades above the 2SD lower Bollinger band on the closing basis, we enter at market using the prior swing low minus five points as the stop. We set our target for the first unit at half the amount of risk; if it is hit, we move the stop to breakeven for the rest of the position.
We then look for the second unit to trade up to the upper Bollinger band and exit the position only if the pair closes out of the 3SD-2SD Bollinger band channel, suggesting that the uptrend move is over.
Rules for the Long Trade
- On the daily set-up, place a 20-period SMA and make
sure that the price is above the moving average on a closing basis
- Take only long trades in the direction of the
trend
- Move to the hourly charts and place two sets of
Bollinger bands on the chart. The first pair of Bollinger bands should be set
to 3SD and the second pair should be set to 2SD
- Once the price breaks through and closes above the
lower 3SD-2SD Bollinger band channel on an hourly basis, buy at market
- Set a stop at the swing low minus five points and
calculate your risk (Risk=Entry Price - Stop Price). (Traders who want to give
the set-up a little more room can use swing low minus ten points as their
stop.)
- Set a profit target for the first unit at 50% of
risk. (So, if you are risking 40 points on the trade, place a take-profit
limit order 20 points above entry.)
- Move the stop to breakeven when the first profit
target is hit
- Exit the second unit when the price closes below the upper 3SD-2SD Bollinger band channel, or at breakeven, whichever comes first
Rules for the Short Trade
- On the daily set-up, place a 20-period SMA and make
sure that the price is below the moving average on the closing basis
- Take only short trades in the direction of the
trend
- Move to the hourly charts and place two sets of
Bollinger bands on the chart. The first pair of Bollinger bands should be set
to 3SD and the second pair should be set to 2SD
- Once price breaks through and closes above the upper
3SD-2SD Bollinger band channel on an hourly basis, sell at market
- Set a stop at swing low plus five points and
calculate your risk (Risk = Entry Price - Stop Price). (Traders who want to
give the set-up a little more room can use swing high plus ten points as their
stop.)
- Set profit target for the first unit at 50% of risk.
(So, if you are risking 40 points on the trade, then place a take-profit limit
order 20 points above entry.)
- Move stop to breakeven when the first profit target
is hit
- Exit the second unit when price closes above the lower 3SD-2SD Bollinger band channel or at breakeven, whichever comes first
Like any set-up, there are times when it will fail, so it is important to be disciplined with your stops and only take the amount of risk you can afford in your personal trading account.
However, if you follow the rules closely for this set-up, you'll find it to be a disciplined way to trade a trend with rational, objective measures for when to enter and exit.
By Boris Schlossberg of BKForex.com
