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VOLATILITY AND MARKET BEHAVIOR
I believe there is a direct link between changing market behavior and volatility. I believe they are associated and one cannot change without the other. When volatility is low, when the average day’s range is 9 – 12 points or less, the market behavior shows congestion with ranging reversals. This is the type of market that is certainly not conducive to the trend traders and those looking for breakout entries. This is where the floor traders make hay and go searching for the stops, both high and low. Everyone gets skinned.
When the daily ranges increase to an average of 15 – 20 or more points, then one sees trends developing and the trend trader and those looking for breakout trades make up lost ground. This is the time those wishing to play the reversal or fading game and shorting resistance prices, and buying support prices, pay the price.
It has been said that 75% of the time, the market congests, and 25% of the time it trends. I don’t know if someone just thought this up, or if there is factual data to back it up. If it is true, then perhaps we could do worse than determining the pivot point where the volatility changes from the congestive stage to the trending stage by determining past daily ranges and if the average is above X points, then we trend trade. If below X points, we countertrend trade and fade the market. If it’s just so much gumph, then we couldn’t do worse than flipping a coin to decide direction. Makes room for thought.
With all the statistical & mathematical formula’s that are on the market these days, one would think there would be some indicator to warn us – on a regular & reliable basis, which way one should trade. Problem is, they work sometimes, and not other times. This applies to all the formula’s and results in the old maxim that “no one can predict what the market will do tomorrow or in the future”. Everyone says this, and yet they go on using those same old approaches.
What we have to do is come up with something new. Some new radical approach, that probably shouldn’t work, but does. When to trend and when to fade. That is the question.
This leads us back to volatility. One would think that there would be a relationship between volatility and volume. This year, there has been a decrease in trading volume, with today being about the lowest volume day this year. Does this mean reduced volatility? Today, there was a range in the s&p of 19 points. Not exactly low volatility. And since the first of the year, in the s&p, there have been two 1000 point changes in direction, and one 1200 point change. One would think that with low volume, there would be a reduction in daily ranges. But not necessarily so.
And yet, market behavior changes. Most of us are trend traders and look for breakout entries. Worked very well in 2000 and very poorly in 2002. What was the change? How does one trade a swing or long term trading system in a 4 month market where there is a 1000 point drop, a 1000 point rise and a 1200 point drop again? You say, well, if I can get in 200 points from the top and 200 points after the bottom, I could come away with a 600 point profit. But where do you place your stops? There were many 200 – 300 reactive moves, and which one would herald a change in direction? I suppose a general trend line on top of the highs would probably be the best indicator for the long term trader. But when a 500 point reaction occurs, and then the market continues in the same direction, one is properly buggered.
For the day trader, the most necessary component is volatility. One must have movement and range to be successful. This applies mostly to those who trend. So we come back to the question of predetermining when will the range of the next day be sufficient to benefit us? Without the proper answer, we have to rely on those indicators that have shown in the past to be more right than wrong and hope that the rights are larger than the wrongs. When you think about it, not the best approach, but the only one available without further discoveries.
And that is what this rambling diatribe is about. To try to get you thinking about different approaches to the question of – “should I trade tomorrow, or let it slide till a better time comes along?” What is the indicator or set of circumstances that would encourage a trade? What dictates whether tomorrow will have sufficient range to allow my system to make money? Is today’s range, or X number of past day’s ranges, an indication of tomorrow’s range? Do market changes occur with “punctuated equilibrium” or as a “gradual evolution”? Where is the point when trending systems cease to work and fading becomes the norm? Why, if the future is just a continuation of the past, are we so often wrong in our premises? Why do systems seem to work for a period of time, and then go in the tank, perhaps to recover at a later date, but not without considerable drawdowns? Why does market behavior change?
What dictates what will happen tomorrow?
GOOD LUCK AND GOOD TRADING
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