This post is a continuation of my series on
different market states. I want to briefly remind you that market can be in 4
types of states at any given time: calm range, calm trend, volatile range and
volatile trend. Each of the states requires specific ways of analysis and
trading. Before you make any decision to trade you need to define what
conditions are in the market and only then wait for opportunities to implement
one or another strategy. I have already covered calm range and calm trend
trading strategies and today I want to define volatile trend market conditions
and shape a method for trading this specific market state.
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It is very easy when you see the market orderly
making higher highs and higher lows in an uptrend or lower highs and lower lows
in an uptrend. It is also easy to trade orderly swings in a calm range. It is
more difficult, however, to trade choppy trends that rally high, then go
sharply down, then again up, then down. Nevertheless, if looking at longer time
frames you see some direction, there definitely are ways to spot areas of
probably support and resistance and to trade those to make profits.
When you are through with the article, please read related articles and watch a video:
Nicolas Darvas trading method
When you are through with the article, please read related articles and watch a video:
Nicolas Darvas trading method
What
is a volatile trend?
I define volatile trend as price move in a clear
direction within the boundaries of a channel. There is a specific trajectory of
the move and you can draw two trendlines that the price is confined to till the
trend is broken and prices reverse or a new channel is formed. Some people give
names for those trendlines: inside and outside of a channel. Whatever you call
it, the point is to understand price action inside the channel that is caged
within those lines.
2009 saw a very volatile trend in eur/usd pair that
lasted for eight months. I want you to look at the chart and see how eur/usd
travelled upwards that year. That’s what I call a volatile trend! If you
carefully analyze the price action of the pair in 2009 you will surely notice
that the pair managed to form two short term volatile swings downwards and one
longer term trend upwards.
Market
conditions change very often
It is quite natural for a price to break out of a
range (calm or volatile), form calm or volatile trend, then shift to volatile
(or calm) trend, or to volatile or calm range. This happens because market
absorbs all fundamental factors that have been running one move or another and
this causes market conditions to change. Depending on the type of factors that
start driving the market after initial factors change, market may shift into
any of the states I have mentioned above. All moves (trends) come to an end and
the manner markets move changes too. So, you should spend more time for
analysis and less for trading at all times, especially when market conditions
start changing. Now, let’s come back to eur/usd pair in 2009 and see how market
conditions changed a few times per year.
Analysis
of 2009 eur/usd trends
The year started from a collapse of prices after
forming a peak at the end of the year when strong calm trend upwards finished. The
early move down (from the 5th of January) started as a calm trend
and later (on the 23rd of January) transformed into volatile
(channel type) downtrend. It lasted till the middle of March when the volatile
downtrend (in a shape of a channel) was broken and a short calm up trend
started. It lasted only about a week and then a short volatile down trend
started. It lasted till the first of May when the down trend channel was broken
upwards and a long (6 months) volatile uptrend started that lasted till the
beginning of December when upward trend channel was broken downwards and a calm
bearish trend started. So, we had three volatile trends in 2009, two short term
down and one longer term up.
How
do you trade volatile trends
Since I see volatile trends as price action caged
within a channel and moving in a clear direction it is best to enter your
trades when market corrects to the support trend line (if the move is upwards)
and to the resistance trend line (if the move is downwards). I want to trade
only in the direction of a trend and keep my positions longer than I do in day
trading.
Entries,
stops and exits
The points when price reaches a trendline are best
for entries. I do not have a magical mathematical exact rule for that, but
rather use a few ways of entering the market, whichever seems to be the best at
the moment. As I am not purely a technician, but use a balanced
techno-fundamental approach to market price action I watch for both technical
and fundamental confirmations where and when I should jump into a trade. At
times, I do pure technical trades at other times purely fundamental and most
often I have mixed trades.
A nice technical way would be to place a sell stop
below the low of the day at the top of the channel if the trend is downwards
(meaning the counter trend rally is over). If we take as an example eur/usd
short term volatile trend from the 18th of January to 12th
of March you would have placed a sell stop below the low of 27th of
January at 1.3118 as the price hit the top of the channel. Your stop would have
been above the high of the same day at 1.3330.
What about exits? I hold to a philosophy that it is
very difficult to predict tops and bottoms, so I want to catch the bulk of the
move, not the entire move. In our instance I would have exited (taken my
profits) at the previous low of the channel at about 1.2760 with about 250 pips
of profit. It was possible to trade the rest of the move down in some ways, but
you would have used other rules and methods for entries, but the same for stops
and exits. Study the chart and find how you would have taken two more short
positions in the move and where you have placed your stops and take profit
orders. It was possible to trade against the prevailing trend following the
same rules (buying above the high of the day when lower trend line was hit,
with a stop below the low of the same day). However, exits would have been more
problematic as this is downtrend and previous high was not reached. You should
find more advanced and complicated rules for trading against the trend.
You should also not forget that we look at the chart
in retrospect knowing and seeing what happened, but at the time the only thing
you would have known was that the pair was in a downtrend, the move was slowing
and it was your best intelligent guess that the pair will either go into a range
or continue going down in a slower fashion.
That’s why I also watch fundamentals closely to get
the grasp of where the market might be going and in what manner in the nearest
future. The fundamental way for entries would have been to wait for important
fundamental news and market reaction to it and go with the flow. Read about my
Forex news trading strategy to see what I mean.
Trading
breakouts of the channels
Another excellent way to trade these volatile trends
is to trade breakouts of the channels. Most often than not you have fast and
calm trends developing right after that. They are often short lived, but the
distance the price travels after a breakout of the channel is pretty attractive
for any swing or trend trader. All three volatile trends of 2009 were followed
by channel breaks and followed by fast calm trends. Look at the chart to see
for yourself.
How could you have traded those? In this case rules
for entries and stops are very simple. You just have to enter your order the
day the channel closes after breaking the channel. If a downward channel is
broken upwards you enter a buy stop position above the high of the day when
market closes outside the channel. A stop loss order should be below the low of
the same day. If an upward channel is broken downwards you enter a sell stop
position below the low day of the day when the market closes outside the
channel. The stop loss order should be above the high of the same day.
Exits are as always the most difficult part. Having
a few orders entered gives you a better choice for exits as you can exit the
first position when you have some profits (at an even number or closest
support/resistance level) and let the rest of your position ride with the
market. There are a lot of ways how to exit the rest of your position. Some traders
close bit by bit when market makes a new high (even daily (in an uptrend)) or a
new low (even daily (in a downtrend)). Others use a ten/twenty day low/high
rule. If a market moves below ten/twenty day low in an uptrend or above
ten/twenty day high in a downtrend they would automatically close all of their
position. Some look at historical charts and determine to exit before some
levels are reached.
As nobody really knows when the trend will end this
part is the most difficult. However, as the market has some momentum in these
breaks you can definitely grab nice cash and leave some of the table without
big regrets. 95 percent of traders are losing their money anyway. 3 percent are
on break even. So, if you manage catch half of the move and come out with
profits you are among 2 percent of traders who are really making money.
Conclusion
Volatile trends most often move in waves in a
channel. You must trade only in the direction of the prevailing move and try to
avoid counter trend moves. Entries and stops are the easiest part. You will
have to think carefully how to exit your trades and cash in your profits. Wait
also for breakouts from the channels as these often create fast and calm trends
(with minor retracements and counter trend moves). And yes, do not forget money
management. Never risk everything on one trade. Learn to protect your capital
and with time you will learn how to make it.
Ok. I hope you benefited from the post. I would
continue the topic of different market states in my next post. Hope to do it
very soon! If you liked the post I would also be happy if you gave a plus on
Google+, tweeted, liked it on Facebook and other social platforms. Have a nice
day.
Disclaimer
Trading
financial markets carries a high level of risk, and may not be suitable for all
investors. All information on the blog http://trend0.blogspot.com/ is of educational
nature and cannot be considered as advice, recommendation or signals to trade
in any financial markets.