We have talked about the importance of applying a flexible trading approach to counter the effects of changing market conditions before. For example, when volatility is high you should usually use wider stop loss and take profit placement and adjust your risk to avoid premature exits when price swings wider. When volatility is lower, you should aim for more conservative targets.
Many people do not change their approach when the markets change which then typically leads to inconsistent results. If you have ever wondered why your results vary so much, there is a good chance that your static trading approach can’t deal with dynamic markets.
The markets are the same now as they were five or ten years ago because they keep changing-just like they did then. – Ed Seykota
In order for you to adapt efficiently to changing market conditions, we will explain 4 of the most important tools and indicators for traders that may help you turn your trading approach into a much more robust system. We recommend checking those 4 tools every morning before you start your trading day to get a feeling for how markets have been changing and which market state we are currently in.
Volatility – VIX vs. ATR
Volatility is among the most important dynamic variables of trading and the magnitude of volatility can change quickly with significant consequences. You can read about why and how you should adapt to volatility in our article here.
To get a feeling for overall market volatility, we recommend taking a look at the broader market VIX which measures the volatility of the S&P500. The VIX can already tell you a lot about the current investor sentiment and price movements.
However, when it comes to actually adapting with your trading decisions, we recommend the ATR indicator because it measures the individual instrument volatility. One quick look at the ATR tells you immediately if volatility is high or low and you can then adjust your order placement accordingly.
Momentum – RSI, Stochastic, ADX
Momentum tells you how strong price moves in one direction which basically means that momentum analyzes trend strength.
Being able to tell whether you are in a trend or in a range-bound environment can further improve your trading decisions. Range traders should stay away from trending markets because their support and resistance zones are more likely to break; trend traders should avoid low momentum periods because price will usually not move as far.
The RSI can be used to measure the momentum of price movements; high or low readings suggest that you are either in an uptrend or downtrend and an RSI in the middle is indicating a low momentum market. You could also use the Stochastic or ADX indicator. All provide very similar results.
Directional bias – Moving averages
It is usually very important to know whether you are in an uptrend or in a downtrend. Statistical research showed that prices usually moves more rationally during uptrends. Downtrends, on the other hand, tend to follow different rules and they are often more emotion-driven which usually leads to faster and more erratic price moves.
Moving averages are the ideal tool to differentiate between bull and bear markets and you can immediately see on which side of the moving average price is on and how far price has pulled away from the moving average already.
Furthermore, even professional traders use moving averages as a filter for long and short trades. Marty Schwartz, for example, said that he only takes long trades when the market is above his moving average and he only takes shorts when it’s below the moving average. Such a seemingly simple rule can potentially make a big difference in your trading approach.
Greed and Fear Index
Fear and greed are driving the markets. Investor sentiment and risk appetite often determines where you should look for trades. For example, when fear is high and risk appetite is low, equities tend to underperform as investors are looking to buy “safer” and low yielding assets, such as safe haven currencies, gold or government bonds. When greed is high and investors have a higher risk appetite, equities are usually the best performers while gold, bonds and safe haven currencies underperform.
CNN’s greed and fear index analyzes a variety of different market indicators such as bond returns, put/call ratios and market strength. Taking a look at the fear and greed index to get a feeling for market sentiment should be in everyone’s trading routine.
Knowing how investors position themselves is important for your market selection. Knowing which markets investors are looking for can help you pick faster moving markets while staying away from markets that have a higher chance of consolidating.
Flexible markets and dynamic strategies
A major problem most retail traders have is that their trading strategies and trading principles are too static while financial markets are highly dynamic and complex structures. Incorrect stop and take profit placement is usually a much greater problem than using “the wrong indicators”, although most retail traders would argue otherwise.
Building a trading approach that allows you to adjust to changing market environments is very important if you want to achieve more stable and consistent results potentially. Incorporating the previously mentioned tools into your daily routine provides a good overview over the markets you trade.
There is a substantial risk of loss in futures trading. Past performance is not indicative of future results. The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders
