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Thursday, April 18, 2013

Volatile trend trading

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. 


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

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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. 

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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. 


Trading financial markets carries a high level of risk, and may not be suitable for all investors. All information on the blog is of educational nature and cannot be considered as advice, recommendation or signals to trade in any financial markets.