Market condition

How to orient your strategy according to the state of the market

Discussion points:

  • Traders should seek to focus their strategies in appropriate market conditions.
  • The analysis over several periods can provide a big picture of a market.
  • Traders can choose to trade trends, ranges or breakouts based on their analysis.

In our last article, we looked at TThe market life cycle. As we have seen, the markets often display one of the three main market “conditions”, which can greatly refer to how this trader should seek to speculate.

Tendencies show a bias that has been displayed on the market; and when a strong trend is available, the trader’s job is simple: trade in the direction of that trend. If the trend is up, the trader should look to buy; and if the trend is down, the trader should look to sell.

Unfortunately, trends don’t always exist; and when this often leads to traffic jams, price movements linked to the range as the bulls and bears both fight for control of the market in search of the next trend. These surroundings limited to the range can be more dangerous, and given the limited upside that might be available, many traders will often avoid trading the range; instead of waiting for the inevitable escape which can end the range and lead to a new trend.

The varying tones that a market can show

Image taken from The market life cycle

In this article, we will discuss how traders might seek to focus their strategies on the appropriate market conditions.

The advantage of multiple delays

The value of having the big picture in a market cannot be understated. To think about the value of a multi-time period analysis, think of trading a currency pair like buying a house.

If you’re thinking about buying a home, you’ll probably want to get more of a glimpse than just driving around and taking a quick peek. It’s like trading a currency pair seeing only one period.

When buying a home, you’ll probably want to get out of the car and take a walk to make sure the backyard isn’t a complete mess. You want to check the foundation to make sure that you are not going to have exorbitant repair expenses in the future. You want to get as much information as possible to make the smartest buying decision possible.

Trading in a market is not that different, the more information you have, the more you can make an informed decision.

In Negotiation deadlines, we offer common timeframes based on the desired shelf life.

Multiple time intervals for diagnostics / trend capture

How_to_Direct_Your_Strategy_body_Picture_3.png, How to orient your strategy according to the state of the market

If a trader is looking to hold a position for a few hours to a few days (commonly referred to as “Swing Trading”), the four hour graph may be the optimal time to enter positions.

And if the four hour time frame is used to enter positions, the daily chart can be used to assess the trend (or lack thereof); so that the trader can ensure that he is focusing the optimal approach on the prevailing market conditions.

Or maybe a longer term trader wants to use the daily chart for trading. Well then the weekly chart can be used as a longer time frame to guide the decision making processes of the trader.

The advantage of using a longer time frame in deciding which strategy to use is that the trader can take more information into account, getting a sense of the “big picture” before executing their strategies. .

Measure the strength of the trend (or lack thereof)

Once a trader has determined the time frame within which they want to assess the dominant trend, they can then focus on studying the strength of that trend.

Price action is a popular mechanism for doing so. Traders can simply check to see if a market is hitting “highs” and “highs”. If this happens, the trader is witnessing an uptrend and may seek to move to a shorter time frame with the goal of buying as efficiently as possible. The image below shows how a trader using price action can seek to buy in a shorter time frame:

Price action can be beneficial for trend scoring and entry plotting

How_to_Direct_Your_Strategy_body_Picture_1.png, How to orient your strategy according to the state of the market

Image taken from Using price action to trade trends

The ADX indicator is another popular way to gauge the strength of a trend on the longer term chart. ADX, or the average directional index is an indicator created by J. Welles Wilder which was designed specifically to assess the strength of the trend. The downside is that it doesn’t show in which direction the trend might move, only if the trend is “strong” or “weak”.

Traders can use the ADX indicator on the longer term chart to determine whether or not a trend is being observed in the market. If values ​​exceed 30 on ADX, traders will often look to execute strategies based on trends.

The average directional index (ADX)

How_to_Direct_Your_Strategy_body_The_Average_Directional_Index.png, How to orient your strategy according to the state of the market

Image taken from ADX: the average directional index

If the reads are below 30, traders will often look to use range or breakout strategies.

Now that the trend is determined, what is‘s Following?

The shortest timeframe is where the trader will often seek to enter the market based on the analysis on the longest timeframe.

If a trend has been found over a longer period of time, the trader’s job is to find a way to go in the direction of that trend. Over a shorter period, the trader may look to buy bullish trends at a lower cost, or sell bearish trends at a high price. This can be done with Price action; or traders may seek to incorporate indicators to provide a “trigger” in the direction of the long-term trend over a shorter period. Some common indicators for triggering positions over a shorter period are MACD, Stochastic, and the Commodity Channel Index (CCI).

The Commodity Channel Index may offer many entry opportunities

How_to_Direct_Your_Strategy_body_Picture_4.png, How to orient your strategy according to the state of the market

Taken from When the market gives forks, trade forks!

If a range-related market condition has been observed over a longer period of time, the trader has another decision to make before deciding how to enter: Does the trader want to trade the continuation of the range, or the eventual breakout?

The logic of range entry and breakout is directly opposed: trading ranges involves selling highs and buying lows (in anticipation of the range continuing), while trading breakouts involves buying new highs and selling new lows (pending a breakout bringing new highs or new lows in the market). We explain how traders can seek to approach ranges more in depth in the article, How to trade ranges.

If trading for the breakout, traders may look to place entry orders slightly outside the support or resistance levels so that once a new high or low is printed, the trade is entered and the trader can look for new highs or lows. We talked about how this can be done in the article, Negotiate the break.

If traders are looking to trade the range, an oscillator can be used in the same way that a trader would buy or sell in a trend (with the notable exception that the upside is limited). In both trends and ranges, traders want to look to “buy low” and “sell high”. The same types of tools can be used to determine when to buy and when to sell; MACD, Stochastic, and CCI are all popular mechanisms for trading in market conditions related to a range, just as they are with trends.

– Written by James Stanley

James is available on Twitter @JStanleyFX

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