There is a season - turn, turn, turn
And a time to every purpose under heaven
A time to gain, a time to lose
A time to rend, a time to sew "
-The Byrds, 1965
Knowing what environment to trade in is often the missing component to trading plans. If you can identify when to trade and when not to trade, you'll find trading a lot easier than most. Of course, you would believe it to be a carnal sin to not be in the market 100% of the time but that just isn't the case for individual traders like you and me.
The key thing you want to avoid is just entering a trade regardless of the overall technical conditions. If you pay no attention to the overall conditions, the overall market could be in a large range with no ability to breakout, which leads to many false breakouts. Because many traders enjoy trading trends, false breakouts can be the death nail to many new traders.
The Two Market Types That Deserve Your Focus
For simplicity sakes, there are two types of market environments that are known as either a trending or impulsive market or a ranging or corrective market. Like the name sounds, an impulsive market is not bound by past price extremes and shows a consistent ability to push new highs in an uptrend or new lows in a downtrend. Conversely, a ranging or corrective market often resists moving past prior price action extremes and will move against a prior impulsive move by a Fibonacci relationship.
The beauty of Forex trading is that I've seen traders make careers out of both environments. A trending environment favors those who like to take advantage of a major monetary policy divergence where one country like the UK in early 2014 continue to see a robust recorvery which could push them to raise rates early than anticipated against a weaker currency. In the best case scenarios, a trend can go unscathed for months at a time like GBP/CAD in 2013 / 2014.
A ranging market favors a buy low and sell high mentality. Buy low and sell high works well in a ranging market because highs and lows are well defined whereas a selling high often means leaving a lot of money on the table in a trending or impulsive market because the market can be much higher in a few weeks from today. From the experience of GCM, whom I am currency analyst and trading instructor for, we've found that new traders do better in a range bound environment because a losing trade can eventually work its way back into profitability where as if you're on the wrong side of the trend, you may have to be forced out if you can't take yourself out.
There are many tools that traders in the Forex market can look to before determining the overall market condition. Only when the market confirms that it is acting within the scope of your trading preference should you then look to take a trade. Here's a breakdown of how you can confirm the market environment as trending or range-bound.
Relative Strength Index (RSI)
Most new traders know the RSI as the oscillator that travels between 70 and 30 and that you should buy the Forex Pair when RSI crosses above 30 and sell when it crosses below 70 however, this logic only really holds in a range bound market. If you're a trend-favoring trading and you notice the RSI pushing down to 20 and never breaking above 60 then you're in a strong downtrend. Conversely, if you see RSI pushing into and above 80 but having a hard time pushing below 40 then the currency pair would be in a strong and resilient uptrend until 40 is broken.
Ichimoku (The Cloud Indicator)
Ichimoku is not just one indicator, but multiple indicators wrapped into one. It is often known as the cloud indicator because it produces a cloud on the chart that acts as a price floor or support in an uptrend and in a downtrend the cloud acts as a price ceiling or resistance. Over the following weeks you'll learn a lot about the dynamics of Ichimoku to keep you on the right side of the market while minimizing losses.
Simple Moving Average Crossover (21& 55)
Before the invent of high-powered trading platforms offering libraries of indicators, there were simple yet often effective trading systems. One of the first technical trading systems was a moving average crossover system. In its simplest form, a moving average crossover looks to help traders enter in the direction of the trend by buying when the faster / smaller moving average (like the 21 day moving average) crosses above the slower / larger moving average (like the 55 day moving average).
Any trader can utilize these tools to learn how to identify a worthy trend and / or market environment to trade. However, these tools are only meant to help you recognize the environment. We'll break down developing an objective entry on the charts in the next lesson.
Happy Trading!
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