Here’s the thing:
On the surface,
it looks like the market can only do 1 of 2 things — either a range or a trend.
But if you look deeper, there are nuances in a range and trending market.
And this can be
the difference between entering your trades too early, too late, or at the
worst possible time.
So in this lesson, you’ll learn:
·
What is a range contraction and expansion
·
How to trade the 3 different types of trend
·
How the market moves in volatility cycles
Once you’ve
learned it, you’ll never see the market in the same way again. Let’s begin…
Range
markets
A market is in a range when
trading between Support and Resistance.
From an orderflow perspective, the market is in equilibrium as buying and selling
pressure are contained within the highs and lows of the range (if you think about
this, the accumulation and distribution stage are actually range
markets).
Now you’re probably thinking:
“That’s easy, I’ll just buy Support and sell Resistance”. That’s possible.
But there’s more to it because you will encounter range expansion and range
contraction, which
makes things a little trickier.
Let me explain…
Range expansion
A range expansion occurs when price breaks out of Support/Resistance, only
to go back
into the range (thereby expanding the range itself).
And it fools a lot of breakout traders as they trade the breakout, only to watch
the markets
reverse its direction.
This is what I mean:
This scenario is “tricky” as breakouts tend to fail and trading at the edges
of the range (going long Support or short Resistance) may still stop you
out of your trade.
In my opinion, a better to trade this market condition is to wait for the false
breakout to
occur before establishing a position.
Range contraction
A range contraction occurs when the price is within an established range,
and then
forms an even tighter range within the range.
One reason is because an important news event is coming up, and traders
wait on the sidelines
till the new is out.
Here’s an example:
Now, you can trade the break of the tight range, but the markets could whip
both the highs
and lows of the range before making the “real move”.
Alternatively, you can let the market make its move and then enter on a
pullback (but you may
risk missing the move if the market doesn’t retrace).
Clearly, both
approaches have their pros and cons, and there’s no right or wrong down here.
Next, we will talk about trending markets…
Trending markets
A market is trending when there’s an imbalance of
buying/selling pressure.
In an uptrend, you have an imbalance of buying pressure as the buyers are in
control. On the
chart, you will see higher highs and lows.
In a downtrend, you have an imbalance of selling pressure as the sellers are in
control. On the
chart, you will see lower highs and lows.
But… what if you get a chart
that looks like this?
Is this an uptrend, range, or
downtrend?
Uh
oh.
And this is the problem when you define trends using higher highs and lows
— there is
subjectivity involved.
So, what can you do?
You can use the 200-period moving average (MA) to help you
with it. Here’s how…
·
If the price is above 200MA, then it’s a
long-term uptrend
·
If the price is below 200MA, then it’s a
long-term downtrend Here’s an example:
Now, identifying the highs and lows in the markets isn’t enough to trade trends
because not all
trends are created equal.
Some trends are
more favorable to trade breakouts, and some to trade pullbacks. So, let’s take
things a step further and classify the different types of trends.
They are:
·
Strong trend
·
Healthy trend
·
Weak trend
Strong uptrend – In a strong uptrend, the buyers are in control
with little selling pressure.
You can expect this trend to have shallow pullbacks —barely retracing beyond
the 20MA. In some cases, you will get no selling pressure as the trend goe
s parabolic.
This makes it difficult to enter on a pullback because the market hardly
retraces and then continues
trading higher.
The best way to
trade this trend is on a breakout or, to find an entry on the lower timeframe.
An example:
Healthy uptrend – In a healthy uptrend, the buyers are still in
control with the presence of selling pressure (possibly due to
traders taking profits, or traders looking to take counter-trend
setups).
You can expect this trend to have a decent retracement usually
towards the 50MA, which provides an opportunity to hop on board
the trend.
Now, you can also enter on a breakout but you must “endure” the
retracement back towards 50MA (which drains your mental
capital).
An example:
Weak uptrend – In a weak uptrend, both buyers and sellers are
vying for control, with the buyers having a slight
advantage.
You can expect the market to
have steep pullbacks and trades beyond the 50MA.
And in this type of trend, the market breaks out of the highs only to retrace
back much
lower (which makes it prone to false breakout).
The best way to enter this trend is
at Support or Resistance. An example:
Does it make
sense? Good.
Next, you’ll learn how volatility
works in the market…
How the market moves in volatility cycles
The market is always changing.
It moves from a period of low
volatility to high volatility and vice versa.
And because of it, you must tweak your strategies accordingly in different volatility
environment.
Low volatility environment
This is my
favorite time to enter a trade because of the favorable risk to reward it
offers. Think about this…
In low volatility period, your stop loss is tighter as the range of
the market is smaller.
This means you
can put on a larger position size for the same level of risk (in nominal
value). Next, you know the market moves from a period of low volatility to high
volatility.
So when volatility expands in
your favor, you can get many R multiples on your trade.
High volatility environment
Things are moving fast in the high volatility trading environment — and it’s
easy to get
caught with the fear of missing out (FOMO) as the market moves quickly.
If you want to trade in such environment, it’s best to wait for the market to
approach your
key levels before you enter a trade.
This offers a sensible place to set your stop loss (instead of placing it randomly),
and only
to get stopped out on the crazy swings.
And if the market doesn’t come to your level, don’t “chase” it because the risk to
reward
isn’t worth the trade.
Instead, move on
to other markets with more sensible price action. An example of high volatility
environment:
Now, these
principles apply to any markets like Forex, stocks, cryptocurrencies, and etc.
So, spend some time learning it as it’ll pay dividends in the long run.
Summary
·
A range market can expand or contract
·
There are 3 types of trend; a strong trend,
healthy trend, and weak trend
·
The market moves from a period of low volatility
to high volatility and vice versa