Type of Approach v/s Type of Market

One of the most perplexing issues that any trader faces is what approach to take when trading the markets. They keep doing something but it works on some days and fails to work on others. This leaves everyone rather confused and wondering whether there really is any way to trade the markets! A mistake that new traders quite frequently make is that they fail to tailor their trading system to the markets they want to trade and to their own psychological make-up. For this we need to understand the different market types and the relationship between the three basic trading systems and the markets to which they are most applicable. To begin, there are really only three types of markets; they are: Trending Trendless High Volatility

In other words, do your homework, analyze what the stock is doing now and what it can be expected to do today/this week (depending on the timeframe that you trade or invest across) and then leave it at that. Of course it is assumed here that your analysis format will include clear-cut criteria for entry, protection as well as exit. The price action of each of them is very different and so the trading approach that has to be brought in has also to differ. Lets look at them individually. Trending Markets A substantial increase or decrease in price extended over a considerable period of time best defines a trending market. It is characterized by sustained directional moves in price with occasional and short-lived corrections. Shift to percentage thinking. Tell yourself that I am going to make 1% on every trade that I take or I will do short-term investing for a 10% return. For example, if you fix a 1-2% return on any trade in Bharti, it would mean locking profits between 4-6 points. This kind of volatility is quite normal for the stock. Dealing with losses in percentage terms is also a lot less damaging emotionally than when it is thought of in absolute terms. Trending markets can be easily identified by a price oscillator or moving average crossover wherein the oscillator were positive or the shorter term MA is consistently above the longer term, and conversely, a downtrend would exist wherein the price oscillator were negative or the shorter term MA is consistently below the longer term.

Trendless or Sideways Markets In its simplest, a trendless market is range-bound, making small up-and-down movements with the only discernable direction being sideways. They often appear to be quite choppy, yet always remain within a fairly defined range.

High Volatility Sometimes news or rumours lead to phases of increased volatility in stocks and the stock prices get whipped around quite often. This is more often seen after a rise rather than after a decline. As a rule of thumb, volatility is a function of distribution and this is therefore seen at price highs rather than lows. High Volatility markets are those that experience significant expansions in their Average True Range following a period of relative calm price action. Other measures of High Volatility would include increased gap frequency, a significant widening of the differential between two moving averages, and jumps in the standard deviation of the underlying price. Choosing the Approach that fits the market type Each of the above markets has corresponding types of systems that best suit them. These systems are: Trend Following Support and Resistance Volatility Expansion

Trend Following Systems These systems, as their name suggests, catch the wave of a trend and ride it until it is exhausted. Many of these systems make virtually all their money on a small number of trades and have a fairly low percentage of wins. A trader using these methods must understand that, more times than not, they will receive false signals and will have many losing trades. However, designed properly, a Trend Following System experiences small losses, albeit frequent ones. Statisticians tell us that almost all markets trend 20% of the time or less. The rest of the time, a market is deemed to be directionless. In order to ensure that the trader will be able to catch the Big Trend, they must be willing to be in the market all the time. This is a difficult system to trade because it doesnt provide much in the way of psychological reinforcement; most of the time, your trades are losers and you can experience significant drawdowns. Yet, on balance, one can earn huge profits when a good trend takes over. Trading this way requires patience and discipline. The latter is required to sit on a winning trade until it has run its course. Without this, the trader will exit early from the big winner and end up a loser from all the other trades.

Single, double and even triple moving average systems (and their derivatives) are the most popular among Trend Following Systems. Support and Resistance Systems The underlying premise of this approach is the exact opposite of the Trend Following System. Here, it is the 80% of the time in which a market is without trend upon which traders attempt to capitalize. Traders seek to capture the smaller price moves within a sideways market in order to build profits. Support/Resistances are typified by high win percentage accompanied by small amounts of money won. Traders will go long at the bottom end of the defined range and will sell short at the upper end. As long as the market remains without direction, this method will work quite well. This is an easy system to trade because of the high number of wins and the clear logic of its buying low and selling high viewpoint. It is easy because this is the psychology of most traders. However, it can be very tricky when a market transitions from trendless to trending and losses therein can be considerable. Overbought/Oversold indicators like Stochastics and Relative Strength (smaller period) are often used to generate the traders signals.

Volatility Expansion Systems These types of systems only work well in fast moving, wide-ranging markets. Because of that, you are out of the market a good deal of the time. This is not comfortable for many traders, especially those who feel that they always have to be in on the action. The system is typified by short periods of trading, high win percentages and relatively small wins per trade. The underlying price patterns of the ideal market for this system will include gap openings, daily range expansion, and explosive moves in the price in one direction or the other. Many traders use Average True Range and/ or Standard Deviation to watch for increases in volatility. Which is the Right One for Me? Now that you have an understanding of the three types of trading systems you can choose from, you can select the one that is right for you. It cannot be stressed strongly enough that one cannot trade any system profitably over the long term if that system creates discomfort for them psychologically. So, you must ask yourself, Am I most comfortable following a trend or would I rather sell at tops and buy at bottoms? Do I feel uncomfortable when markets move too quickly? Once you have better insight into yourself as a trader, youll be able to pick the system that is most comfortable for you. Remember, any of them can bring you handsome profits!

Of course, it goes without saying that when the phase of the market changes from one to another, it also calls for a change in the approach. That is the key. One can keep track of these changes by subscribing to any of the market letters available from this website. www.malkansview.com Trading a market that is incongruent with your system is the sure way to ruin. Market type identification, selection of the appropriate system and good discipline are the minimum requirements for success in the markets.

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