One of the main reasons why trading profitably can be so challenging is because traders don’t often fully understand the market environment they are dealing with. Inaccurate interpretations about market conditions inevitably leads to wrong assumptions and wrong trading decisions.
In this article, we show you how to tackle the financial markets in an efficient way and how to correctly establish a market analysis, depending on your own personal trading style.
Define your strategy
You would imagine that traders know what their trading system does, but in most cases they don’t. Thus, the first step is to be clear about what it is that your system does and how you identify high probability trading opportunities.
Are you a trend-following trader and look for established trends? Do you then look for trading opportunities during pullbacks or do you scale into a trend when support and resistance levels are broken? And how do you know a trend is still valid once you are in a trade?
Or do you look for high momentum breakouts after consolidations and range bound markets?
Or do you fade trends and look for reversal around important support and resistance areas?
Your tools
How did you choose your trading tools that help you make trading decisions? Did you choose them according to the premise of your system or did you just look for a random indicator? And which other trading concepts do you use? Are you applying support and resistance principles, do you look for demand and supply areas, do you trade based on volume analysis or do you trade price action and candlestick patterns?
For most traders, approaching their trading in such a way will be an eye opener. The majority of traders follows an inconsistent trading approach and frequently change tools, indicators and concepts to make trading decisions. An inconsistent trading approach leads to inconsistent trading results.
Set aside some time if you are serious about this, and write down what it is that your system does and why you choose the tools you are using.
Your ideal market environment
Now that you have a better understanding of what it is that you are trying to accomplish with your trading strategy, you have to identify your ideal market environment. The mistake most traders make is that they try to find trades all the time, day in and day out, regardless of what the markets are telling them.
As we have said above, if you are a trend trader, you have to look for established trends; if you are a breakout trader, look for high momentum price moves or moves supported by volume; and if you are a range trader, look for low momentum reversals.
The following three tips will help you identify whether you are dealing with a market environment you should be trading in.
The trend follower
The most important thing as a trend follower is to stay away from picking tops and bottoms. Don’t try to predict a trend that you believe could happen; only trade what you can already see. Trend following traders typically miss the first and the last part of a trend because they wait until a trend has been confirmed and they exit when they see the first warning signs – it is their insurance.
The screenshot below shows that, although price has started moving down before it broke the support line, the real trigger for trend followers only occurred after support was broken and when the ADX confirmed a strong trend as it moved above 30. And once in a trade, the analysis of highs and lows is the key concept of any trend following strategy.
The next screenshot shows how people usually trade the markets. Even though the trend is clearly down, most traders would have tried to pick a bottom at the price levels marked with a red X. They believe that if they can predict a reversal and be the first to join a new trend, it could lead to huge winners.
Tip 1: Every day, zoom out to the daily or weekly chart to understand the overall picture and the overall trend. Traders who don’t leave their execution timeframe have a too narrow view.
Tip 2: The ADX is a great trend following indicator. A rising ADX, breaking above 30, can signal a trend. Often, the 30 level of the ADX is called a ‘tiebreaker’ where traders treat markets as ranges when the ADX is below 30 and as trends once it breaks the 30 level.
Tip 3: Once in a trend, the analysis of highs and lows is the most important trading concept. As long as you see new highs or new lows, don’t fight the trend.
Tip 4: Be comfortable with missing a lot of moves. As a trend trader you have to enter a trend after it already on its way.
The range trader
Range trading is quite the opposite of the trend following. Range traders look for fading momentum at important support and resistance levels. However, the most important point is the same as in trend following trading: don’t pick tops and bottoms and wait until a reversal has already happened.
The screenshot below shows a range market. During the range, price traded into the support and resistance boundaries many times. However, the successful range trader does not place his trades right at the levels, but waits until price has started moving away back into the range. The amateur trader typically enters prematurely, before price reached the level and eventually is trapped once the real breakout happens.
Tip 1: Don’t place your trades right at support and resistance levels. Wait until price has moved back into the range.
Tip 2: An ADX below 30 or flat at 30 signals a range market.
Tip 3: When price closes outside the range, get out immediately. Don’t wait for a potential reversal. Those are amateur plays.
The “wait one candle rule”
The problem of most traders are premature entries. They try to pick a bottom although the current trend is still going on or they trade off of support and resistance levels before price has even reached them. Waiting one more candle before you actually make a trading decision can make a real difference in a trader’s performance. Next time you want to enter a trade, wait one more candle. It will be hard to withstand because you probably think that you are going to miss a trade, but you won’t.
With the help of this article, start auditing your trading system, become clear about the premise of your system, choose the tools you use wisely and be clear about the market environment your trading method performs best in.
There is a risk of loss in futures trading. Past performance is not indicative of future results.
