"Turn to the carry" is a variation of the "turn to trend" setup designed for longer-term traders interested in trading in the direction of the positive carry. It has several modifications that make it different from turn to trend, but the general idea behind the setup operates on the same principles of finding entry at the most advantageous pivot points in price action. For those who have the patience for longer-term moves, the strategy creates fewer, but more potent, trades. (For background reading, see Currency Carry Trades 101.)
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How it Works
First and foremost, the setup is only traded in the direction of the carry, which is the direction of positive interest. So, if the Australian dollar yields more interest than the Japanese yen, for AUD/JPY the strategy is only traded from the long side. Similarly, if the British pound carries a higher rate than the euro, for the EUR/GBP setup, the setup would only be traded on the short side. Should, sometime in the future, the Japanese yen yield more interest than the Australian dollar, or the euro carry a higher rate than the British pound, then these rules would be reversed. The one consistent rule is that the trader must trade only in the direction of the currency with the greater interest rate advantage.
Secondly, the turn to the carry uses only daily charts and employs Bollinger Bands® with settings of 2SD (standard deviations) and 1SD instead of the 3SD-2SD combination used in the regular turn trade strategy. The longer time frame is designed to help the trader capture daily interest rolls while remaining on the right side of the directional move. Furthermore, because we are looking for deeper turns in the price action, the break of the 2SD-1SD zone is required to trigger a trade signal. The following are the rules for the turn to the carry variant of this setup. (For more insight, read The Basics Of Bollinger Bands®.)
Rules for the Long Trade
(When the carry positive currency is the base currency)
1. Place two sets of Bollinger Bands® on the daily chart. The first pair of Bollinger Bands® should be set to 2SD and the second pair should be set to 1SD.
2. Once the price breaks through and closes above the lower 2SD-1SD Bollinger Band® channel, buy at market.
3. Set the stop at swing low minus 5 points and calculate your risk (Risk = Entry Price - Stop Price).
4. Set profit target for the first unit at 50% of risk (i.e., if you are risking 100 points on the trade, then place a take-profit limit order 50 points above the entry).
5. Move stop to breakeven when the first profit target is hit.
6. Exit the second unit when price closes above the upper 2SD Bollinger Band® or at breakeven, whichever comes first.
Rules for the Short Trade
(When the carry positive currency is the counter currency)
1. Place two sets of Bollinger Bands® on the daily chart. The first pair of Bollinger Bands® should be set to 2SD, and the second pair should be set to 1SD.
2. Once the price breaks through and closes below the upper 2SD-1SD Bollinger Band® channel, sell at market.
3. Set the stop at swing high plus five points and calculate your risk (Risk = Entry Price - Stop Price).
4. Set the profit target for the first unit at 50% of risk (i.e., if you are risking 100 points on the trade then place a take-profit limit order 50 points above entry).
5. Move the stop to breakeven when the first profit target is hit.
Exit the second unit when price closes below the lower 2SD Bollinger Band® or at breakeven, whichever comes first.
|Figure 1: Turn to Trend, AUD/JPY|
|Source: Fxtrek Intellicharts|
Figure 1 shows an example from the May 2005 to June 2005 period in AUD/JPY when turn to the carry generated two signals, one of which was successful and one that was not.
Let's take a look at the unsuccessful trade first. In the middle of May, we see the currency pair close above the 2SD-1SD Bollinger Band®, and we enter long on the close of the candle at 81.92. The next day, the price inches higher but fails to meet our first profit target and continues to fall. Over the next three days, the decline accelerates and we are stopped out of the trade for a 97-point loss.
Why did we wait so long before liquidating the position? Every trader must walk a fine line between controlling losses and giving the trade enough room to succeed. Using the swing low offers a logical reference point as it is the final price before new lows in the currency are set, and therefore represents the last exit point for most longs. Once that barrier is broken, it could mean that new information has changed the perception of value of most market players, and prices could collapse further. Of course, sometimes prices could simply test a new bottom and then quickly rebound, but making that assumption could be devastating for the trader if he is wrong; in a highly leveraged market like FX, one bad decision could blow up an entire account. Therefore, no matter how frustrating it may seem to be stopped out just as prices reverse (to be "bottom ticked", in trader's lingo), professional traders never let such temporary annoyances affect their judgment and always stay disciplined.
A Second Opportunity
Two days after we are stopped out, a new turn to the carry opportunity presents itself and once again we go long, this time at 81.34. Our risk is a bit smaller this time, at only 70 points. Within three days the pair rallies to our first profit target, and we exit half the position at 81.70, banking 35 points, and move our stop to breakeven. The trade proceeds in our direction for several more days and we still sit tight, collecting the interest spread in the meantime.
On May 26, 2005, the AUD/JPY rallies to the upper 2SD Bollinger Band® and we exit the rest of the position on strength, harvesting 106 points on the second half of the trade. In addition to 141 total points of profit, we also receive approximately 22 points on interest during our time in the trades. Although over the course of two trades we still ended up a bit in the red, the setup showed the power of a disciplined approach in real-life trading. By sticking to our risk parameters and entry rules, we were actually able to neutralize most of the losses of the first trade and maintain our capital in good shape for possible opportunities in the future. (For related reading, check out The Importance of Trading Psychology And Discipline.)
That opportunity occurred in August of 2005 in the same pair, as the turn to the carry setup presented itself once again, as shown in Figure 2.
|Figure 2: Turn to Trend, AUD/JPY|
|Source: Fxtrek Intellicharts|
On Aug. 25, 2005, the AUD/JPY pair breaks out of the lower Bollinger Band® channel and closes at 83.55, prompting us to go long at the open of the next bar with a stop at swing low of 82.60. Note that for the next few days, the pair actually moves against our position, dipping slightly. This price action happens often in this setup as pairs try to work off temporary overbought conditions. Although the price recedes, it never triggers our stop and we remain in the trade, collecting interest in the meantime.
Approximately a week later on Sept. 2, 2005, the AUD/JPY rallies to our first profit target of 84.00 (which represents nearly 50% of our risk); we bank 45 points and move the stop on the rest of the position to breakeven. The very next day, AUD/JPY dips to within a whisker of our stop but does not tag us out. We remain in the trade as it rallies higher for the next three days until finally, on Sept. 8, 2005, we exit on the close, as price pierces the upper Bollinger Band®. The second half of the position generates 181 points of profit. Furthermore, the two-week holding period produces 25 additional points of profit in interest. Altogether, we are able to harvest 251 points on the long AUD/JPY, or approximately 125 points per every lot traded.
Putting all of the trades in the AUD/JPY in perspective, we can see how a disciplined methodical approach pays off over the long term. Although the first trade turned into a loser, costing us 190 points (-97 *2 + 4 points of interest earned), the second trade garnered 141 points in profit and approximately 20 points in interest, nearly offsetting most of the losses. Finally, the third trade generated 226 points of profit and 25 points of interest; overall we walked away collecting 222 points of profit across all of the trades, clearly proving that trading FX is a marathon and not a sprint.
Final Thoughts on the Turn Trade
There are some further variations on the turn trade for you to consider. Those traders who don't like to assume the full risk all the way to the swing low or swing high of the trade can consider using the low/high of the trigger candle as a much tighter stop point. The risk in the strategy will be reduced significantly, but at the cost of having far more frequent stop outs.
In the first example, the stop would be set at the low of the trigger candle, which would be 81.53, or only 40 points away from the 81.92 entry, effectively cutting risk in half. The same approach, however, would cause an unnecessary stop out on our second example, as the slight dip in price would take us out from our 83.55 entry at 83.12, generating 43 points of stop losses before getting us into the trade once more on Aug. 30, 2005, when we had another positive candle close above the 1SD Bollinger Band®. Altogether the -40 points and -43 points of loss would still add up to less than the -97 points of loss on the first trade; traders who like to be right or be out may want to consider this variation on the trade.
The Bottom Line
The turn to carry trade is clearly a longer term strategy, which may be ideally suited for the weekly charts, but be careful; weekly charts could generate extremely wide stops causing the risk-reward parameters to be highly unfavorable. Therefore, being selective on which turn to carry setup to take is crucial for successful implementation of this idea.