- April 12, 2022
- Posted by: CoachShane
- Category: Trading Article
Many traders want to avoid trading in choppy markets for good reason. Often times, the market condition gives no indication of who has the upper hand in a price imbalance.
Having a way to identify choppy price action can help traders avoid placing trades when there is no edge in placing one. But let’s also consider that this type of condition is not useless. From choppy price action, we will eventually return to price that we can trade.
Let me say from the start that this type of observation can be subjective. Each trader may see something a little differently but that is not a bad thing. This makes trading accessible to anybody with the capital and the time to dedicate to becoming a trader.
What Is Choppy Price Action?
This type of price action should not be mistaken for a properly forming rectangle price pattern. Rectangles will often provide trading opportunities between easily identifiable support and resistance levels. Looking at this chart, we can see identifiable areas of support and resistance which can equal trading opportunities.
Looking at the following chart, we can see the movements of price are not as clean. Support and resistance zones are diagonal, momentum candles interspersed with smaller range candles, and that bigger upper shadow isn’t helpful.
This chart would make for some painful trading and skipping this type of price action is probably not a bad idea. The price action seems to be randomly moving without any clear sign of who is in control.
You now know that if you can identify market structure (support/resistance), there is an opportunity to place trades around those levels. You’d need some type of ranging trading strategy to ensure you follow some type of plan in doing so.
How To Identify Choppy Price Action
If you are a day trader or prefer swing trading, finding price action that is not suitable for trading is important. It can keep you out of looking for trading opportunities that have little chance of success.
One of the easiest ways to find price that is choppy is to use a moving average. Since a moving average generally uses the closing prices, as the closing prices have less of a range between each other, price will begin to whip around the average.
The length of the moving average will matter and in this example, I am using a 20 period simple moving average on a daily chart.
On the left, an obvious uptrend is in place along with brief consolidation periods that give an entry into the up move.
The red lines show areas where price is staying close to an average price of the last 20 days. Due to the lack of range between each closing price, the moving average eventually catches up to an area around the majority of price action. The difference between trending price on the left and choppy action in the middle and the right, is obvious.
Using a longer period 100 SMA, we still get a indication of a choppy market although it happens later than the 20 SMA.
Using a longer term average, traders may find trading opportunities in the middle of this chart before the objective indication of a choppy market is seen on the right.
I can’t give you a best moving average to use. It will depend on your trading style but you should try a few different settings to see which matches your eye better. It will also depend on your skill of reading price and understanding the story unfolding on the chart.
Using Price Action
A trending structure is a series of higher highs/lows or lower highs/lows.
Once we see price failing to show that pattern, we could start to consider the possibility that we are entering a different environment. In the highlighted area below, we start to see the trending pattern break down and that can put us on alert that the instrument may not be a good trading candidate.
A trending pattern does change during the transition of trend direction but for a choppy environment, we are looking for price to be contained within price swing levels for a longer period.
This last chart is another lesson. What some traders may think of as choppy, others may see the opportunity that is presented here. Let’s explore that next.
Don’t Confuse Choppy With A Setup Opportunity
What may appear to be choppy conditions that has a high risk potential, may actually be a setup waiting to form.
After price makes a big move in one direction, price will often consolidate which can often look like a mess of price action. If you had time to read the article about chart patterns, you will see that the last chart presented an opportunity.
Price had made almost a 50% jump in price over a two week period. This pattern could be called a triangle pattern of sorts but I just use the term consolidation (understanding the imbalance is the important thing). It’s also a complex correction into the lower trend line. Given the strong move in price and the consolidation, what some would consider choppy, eventually turns into a tradeable pattern.
Even if you didn’t trade the pattern, using it as information that price is tightening as it often does before a breakout, would set you up for the breakout pullback trade on the right (BOPB).
Not All Chop Is The Same
You will have to train your eye to be able to look at a chart and determine if the chop that is present, is worth the effort to explore.
This chart stands out to me as one that I would not even bother to entertain for a trade. Not only is it, objectively, whipping around the moving average, we see momentum pushes mixed with small range candles on both the buyer and seller part. High volatility with low volatility in such a back and forth manner, is a tough trading environment.
Every market participant is going to have to be able to learn what is good chop and what is bad chop. It’s not always black and white no matter how many videos blog posts say it it. All traders should spend time looking at instruments that made a strong move in one direction, consolidated, and then another leg in the same direction. Do your homework to find similarities that you can apply to your own trading.
Is There A Certain Timeframe To Look At?
There’s no need to complicate things. If you take trades off the daily chart, use the daily chart to determine the trading conditions. If you start to use different time frames, you run into the issue of chop on one time frame is actually being a trend on another.
This is the one hour chart of the previous daily chart. While not overly pretty to look at, there are times when mean reversion sets in and sets up a trade. There are also small consolidations and breakouts that hit at least 1R price targets.
Bottom line, what matters most is your trading setups that occur on your trading time frame. Keep your focus on that time frame makes sense because you will get conflicting information the more periods you look at it.
From Chop To Trend
Eventually, a choppy market will break out into a trend trading environment. Sometimes after a long period of consolidation, the runs in the trend can be enormous.
While breakouts on momentum can work, positioning prior to a potential break of the extreme high/lows of choppy price action, can yield great trades.
The kicker is that eventually you will need to find some information that points to one side, buyers or sellers, are taking the lead. You won’t always find it and like the daily chart in the last example, those breakouts will more likely fail.
This chart, using the moving average chop determination method, gives us a sign that the imbalance is favoring the buyers. Not only do we have a spike at support, we start to see higher lows holding against resistance.
If you were using a scan that had closing prices a percentage near a moving average, you’d find a list of stocks, crypto, or even futures markets to dig into.
From your chop scan, if you see a pattern like this chart or any number of chart patterns, you would also have a potential trade setting up. If you were unable to determine any pattern or price action appeared random, you’d skip that chart.
The fact that price was holding near resistance no longer makes this a choppy market but one where there seems to be an edge in a potential buy.
Finding a market that may be in chop is as simple as looking at a moving average or the lack of trending price structure. We don’t need a ton of indicators and timeframes to determine that market state. It should be obvious just looking at price.
Choppy trading conditions do not have to be automatically ignored. After a strong trending run in price, you may eventually see a chart pattern that shows an actual imbalance of buyers and sellers. This can give you an opportunity for a trade.
You may also find a choppy market turns into identifiable support and resistance zones where trading can occur.
You will eventually be able to quickly look at price and determine if it is simply random price or is there an obvious imbalance taking shape. If so, you may want to find an entry price to the actual breakout of the extremes and perhaps catch a massive run in price.