Things change. In trading, that can mean:
- Higher or lower volatility
- Psychological make up of the trader
- Shocking news that rocks the market
- Anything that may affect your risk/reward protocols in your trading plan
Every day the markets ebb and flow and there are times of abnormal activity that must be taken into account. We are not talking just about the markets but the trader themselves.
Some things are easy to measure and because we are not always going to have ideal trading conditions, it’s something we must consider.
“The desire for constant action irrespective of underlying conditions is responsible for many losses in Wall Street even among the professionals, who feel that they must take home some money everyday, as though they were working for regular wages.” – Jesse Livermore
Higher Or Lower Volatility
For those that trade index futures, the VIX is something that is looked at for a measure of the volatility that is taking place in the market. That’s great for an overall view of things but there is a way that makes more sense.
Using certain metrics of the trading instrument of interest.
This involves logging your trades, trade journals and statistics of the markets such as:
- Average daily volume traded
- Average daily range
Notice that “daily” was used. You can actually get a better view by using a 30 minute time frame so you can also measure when the best times of the day are for that instrument. There are a few ways you can track the market conditions so decide on one and implement it into your daily trading rituals.
Red Light Or Green Light For Trading
You’ve determined by some measure that you are facing a market with abnormal activity or a change in the volatility of the market and two questions come up:
- Should you trade in these different conditions?
- Should you sit on your hands?
If you are going to be involved in the market, are you using the same trading strategy? Trades will often have different strategies for trading a range as opposed to trading a smooth trending market.
Will you lighten up on the risk parameters? When traders are trading in conditions that require a little more “work” to understand, risk parameters are often tweaked. In my trading, a failure test of highs or low is done with partial position because the trade setup could still be forming on the higher time frame.
The answers to those questions are going to depend on the trading strategy you will use, the size of your trading account and the personality of the trader. There is no right answer but one thing is always the right answer: don’t bet too much on a trade where the loss will wipe you out.
Whatever you decide to do, ensure you have thought about the changing conditions and have included different trading rules to deal with them. Once you’ve contemplated these scenarios and have put them in your trading plan, you are less likely to deviate from your overall plan.
You Have No Plan?
It’s a tall order asking you to put these things down in your trading plan. Most traders don’t even have a simple list of how they will approach each trade so asking you to deal with conditions before they happen is wishful thinking.
And I am not talking about:
- “If markets start to speed up, I’ll smack them and make a ton of cash”
- “I won’t trade if things get really volatile”
- “If it’s really slow I’ll just leave it and finish for the day early.”
Is this enough though? No, not in my opinion. I see people getting sucked into different trading conditions without a plan all the time.
There are traders who have no idea that the conditions have changed quickly enough to adapt their trading strategy. Even those who do notice, some just like to trade in less than ideal conditions. There’s a reason people love to trade news spikes even though the risk of slippage is huge.
If we trade in a market which is exhibiting particularly slow conditions, the chances are that the swings will be fewer in number, the volume will be lower and ranges will be smaller. This means fewer opportunities to enter or exit a trade and holding a trade for longer.
Your Experience Won’t Always Save You
When a pitcher is throwing well, batters will still connect and it’s up to the fielders to do their job. When the fielders continue to make errors, they are leaving their pitcher in longer than they have to. Over time, the pitcher weakens and they may not be able to rack up the innings.
It’s the same thing for an experienced trader.
If you are in a trade for longer than usual, it can start to take a toll on the trader psychologically. When markets are showing high volatility and the trader uses the same trading strategies, being exposed to higher risk for the rewards is usually the result. Traders begin to “snatch at winners and hold losers”.
You must create rules to manage unusual activity in the market and especially be on a alert for signs the market is changing to a higher gear. We want to trade and make money but to do so, we have to be prepared for the changing personality of the market and stick to our rules of trading engagement.