Does Your Trading System Account for Different Market Conditions?

Does Your Trading System Account for Different Market Conditions?


This article on Limitations of a Single Trading System is the opinion of Optimus Futures.

tradiing system

Technical futures traders invest significant time and resources in crafting a reliable trading system that can help them extract consistent results from their favorite market (or markets) while continually indulging in research and development to further enhance and improve the method.

In this post, we will highlight the limitations of relying on a single trading system by looking at the recent price action on the Crude Oil and S&P500 Emini futures markets.

Your ‘Edge’ vs Your Trading System

If you happen to be actively involved in trading communities and social groups, you may have noticed that traders that seem to possess a decent amount of trading knowledge and experience often refer to the holy grail in this business as your ‘edge’ as opposed to your ‘trading system’, although most new traders are often found using the terms interchangeably.

Whereas professional traders work on finding and sharpening their ‘edge’ in the market, the vast majority of new traders appear stuck in the hunt for a fantasized trading system that ‘has it all’ when it comes to sound execution across all markets, time frames, and market rhythms.

While a trading system’s focus on pre-set standards for entry and exit may appeal to struggling new traders looking for concrete yet brief answers, seasoned traders understand that no one system can ever potentially ‘have it all’. Instead, they work on developing and sharpening their true edge in the market, which stems from a deep knowledge and understanding of market behavior and dynamics, the right trading approach and trading psychology, and a well-equipped trading arsenal with methods and systems suitable to various market conditions.

The Case for Multiple Trading Methods

One of the most sought-after quests for newer traders is the ability to execute consistent profitability across the different time frames – an uphill task for a confined trading system that has to deal with varying volatility and market rhythm.

Trading System 1

The chart above represents the latest activity on sweet crude oil futures market on the daily time frame. Notice the relative consistency in trading volumes as well as the market rhythm. The market for crude oil has been in a consistent uptrend for the past several months which makes it a comparatively easier market to trade using some of the popular trend trading systems like moving average crossovers and trend continuation systems.

Trading System 2

As a follow-up, try comparing the first chart with the chart above. It is the same crude oil futures market representing the latest price action on an intra-day three-minute time frame. The first noticeable difference is that while we say that both charts represent latest market activity, it is relative to the time frame we are looking. The information on the first chart represents several months of daily price action while the three-minute chart represents price action mostly for the past two trading days.

The other noticeable changes more relevant to our discussion here are laid out on the charts. You should note the volatility spikes on the three-minute time frames as well as definite periods of slow trading versus periods of sharp price movement. You will also note that the price action on the lower intra-day time frame appears more jagged and rough in general compared to the smooth trend that the daily time frame presented.

Price action enthusiasts will quickly chime in here to argue that price action dynamics remain consistent across all markets and time frames, and that is absolutely true. Price action and its most proven dynamics like support and resistance and the candlestick and chart patterns, signify collective ‘herd behavior’ and tend to remain rather consistent across all time frames. This fact, however, does not undermine the real impact that changing volatility can have on smaller time units of trading activity that can dramatically affect the outcome of your trades and your results in general.

Bear in mind that we are not trying to prove that trading on the higher time frames is better or worse than trading on lower time frames or vice versa. We are trying to underscore the difficulty that a trader can potentially face in trying to fit one concrete and objective trading system across the two vastly different trading environments in the hope of attaining equally effective trading results.

The same argument can be stretched to encompass an altogether different problem that new traders constantly struggle with: trying to adjust to different market rhythms on the same time frame.

Trading System 3

The S&P500 Emini futures market currently hosts a perfect example of changing market rhythms. The market that had been strongly trending for months, has for the past several months now been contained within a choppy sideways market rhythm. If you look closely enough at the chart above, you should see price only just pushing past the wedge pattern formation to print a potential breakout, which could mean yet another transition perhaps back towards a trending motion.

Just as a singular trading system can find it difficult to cope with varying volatility, it may also post varying results depending on the prevalent market rhythm. Some systems are designed to benefit from trending market situations, while others fare better in swinging or range bound market conditions. Some are created to benefit from and rely on precise and specific market developments like breakout patterns that often imply a transition into a different market rhythm (for example from a range bound market to a trending market via a chart pattern breakout).

Considering the S&P500 Emini futures market above, it may be implied that many trend traders would have been busy for the first part of the move and would be yawning (or worse still nervous) about the following range bound market action, while traders that thrive on sideways market activity would have been pretty much on the sidelines for the first part of the move when the market was heavily up trending. Breakout traders would be perhaps only just getting excited seeing price finally breakout of a wedge pattern formation.

Notably, though, none of the different market phases above point to flat out zero trading opportunities. They just point to varying opportunities that can be hard to classify within a single trading system, unless the system is so vague and weak that it is better not call it a system at all. The alternative to having a weak and vague system is retaining multiple concrete trading methods each in a ‘ready-to-deploy’ stage, specializing in benefiting from specific market conditions.

Trading systems that favor trending conditions usually employ a subjective longer-term approach allowing the trader to ride the trend as much as possible. These systems may also employ more aggressive trade management approaches that provide enough leeway for the trade to absorb minor pullbacks without being squared off.

It doesn’t take much to realize how such a system could be a disaster in a sideways or volatile market. For these brittle market conditions, traders often employ ‘scalping’ methods built to benefit from quicker short-term price movements with conservative trade management approaches built to limit losses as the market pulls back. These systems may also utilize a higher trading frequency to make up for the smaller gains made on profitable trades and the lower win rate overall stemming from weak or volatile markets conditions.

Given how varying market conditions can demand such versatility in trading methods, it is not hard to fathom why a single trading system or method would barely be able to provide the same consistency in trading results across the different market conditions. By now, we hope you also realize that this is not a problem that a trader must submit to, but one that should trigger the trader to explore other specialist trading systems and expand his or her trading arsenal.

There is a substantial risk of loss in Futures trading. Past performance is not indicative of future results.

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