Key reversal days are simply another name for the price swings we discussed in the section on charting methods. A bullish key reversal day occurs when we see a daily low with higher lows on either side of it, and a bearish key reversal day can be identified as a daily high with lower highs on either side of it.
Although these are great for identifying price swings on charts, they do not form a sound trading methodology; to trade with these formations we need to introduce some discretionary parameters – hence ‘for Dummies’!
Firstly, we need to see the reversal take place in a trending market – we’ll define this clearly by saying that we want to see the instrument making twenty-day highs or lows. This is a rule of thumb, and eighteen or nineteen day highs would be perfectly acceptable as long as the market has clearly undergone a trending period.
Secondly, we want to see strong confirmation of the reversal in price. Some futures traders will enter this trade inter-day, with a break of the lows of the high day. But, being ‘dummies’, we want to see the reversal confirmed by a close that is lower than the lows of the high day. Likewise, we will want to see a close above the highs of the low day to enter long.
Finally, we’ll employ both a ‘hard-stop’ for risk management, and a trailing ‘mental stop’ based on the closing price for profit-taking.
Parameters for buys (rules are reversed for sells).
You might like to try combining this strategy (which is essentially nothing more than the most basic form of traditional swing-trading) with some of the other ideas I have suggested – buying the monthly open, or the inter-market differential indicator. You could also start to introduce some of the market internals and sentiment indicators I have discussed to identify strength or weakness as the highs or lows are made.
You could also experiment with taking half-profits at a fixed target (two standard deviations from the entry, for example), or introducing a mechanism for moving your hard-stop to break-even. Whatever you do though, remember to have a strict set of rules and stick to them - discipline is essential for futures trading!
Although these are great for identifying price swings on charts, they do not form a sound trading methodology; to trade with these formations we need to introduce some discretionary parameters – hence ‘for Dummies’!
Firstly, we need to see the reversal take place in a trending market – we’ll define this clearly by saying that we want to see the instrument making twenty-day highs or lows. This is a rule of thumb, and eighteen or nineteen day highs would be perfectly acceptable as long as the market has clearly undergone a trending period.
Secondly, we want to see strong confirmation of the reversal in price. Some futures traders will enter this trade inter-day, with a break of the lows of the high day. But, being ‘dummies’, we want to see the reversal confirmed by a close that is lower than the lows of the high day. Likewise, we will want to see a close above the highs of the low day to enter long.
Finally, we’ll employ both a ‘hard-stop’ for risk management, and a trailing ‘mental stop’ based on the closing price for profit-taking.
Parameters for buys (rules are reversed for sells).
- Identify an instrument that is making new twenty-day lows – we’ll call this the ‘signal bar’. This strategy works well for the indices and also the currency pairs.
- A long entry is provided by a (cash session) close above the high of the signal bar. Usually this is the subsequent day, but sometimes you may have to wait for several days if the market neither closes higher nor makes new twenty-day lows. Once the higher close occurs, enter long at the close (you can use an ‘on the close’ market buy order to do this).
- Your ‘hard-stop’ should be placed at the lows of the signal bar.
- After three trading days you should start using a trailing stop-loss in addition to the hard-stop (which should remain in situ). This should be trailed at the lows two days prior to the current trading day, and will be activated by a close below this level. This stop should be held mentally, and only ever exercised on the close – if the market breached the stop intra-day but does not close below, this doesn’t count.
- The trailing stop-loss is also your exit, so you should hold your position until it is activated.
You might like to try combining this strategy (which is essentially nothing more than the most basic form of traditional swing-trading) with some of the other ideas I have suggested – buying the monthly open, or the inter-market differential indicator. You could also start to introduce some of the market internals and sentiment indicators I have discussed to identify strength or weakness as the highs or lows are made.
You could also experiment with taking half-profits at a fixed target (two standard deviations from the entry, for example), or introducing a mechanism for moving your hard-stop to break-even. Whatever you do though, remember to have a strict set of rules and stick to them - discipline is essential for futures trading!