Have you ever found that your trading system works great one day but fails miserably the next? If so, your problem is likely market-type identification.
Too many forex traders will trade the same way no matter how the market is behaving. Instead, you should identify the market type first. Then, you can devise a strategy appropriate to that market type. Sounds simple, right?
With the proper technique and a little practice, you will be able to quickly tell what market type you’re in and how to trade it. There are six primary market types in forex that you need to be able to identify:
– Bull Normal
– Bull Volatile
– Bear Normal
– Bear Volatile
– Sideways Quiet
– Sideways Normal
If the market type is quiet, wait for a breakout or range trade. If the market type is bullish, look to buy dips. If it’s bearish, look to sell rallies.
When Market Types Change
Like the weather, market types shift and change. The good news is they do so in a predictable manner. Volatile market types settle into normal then quiet markets. Bull markets turn sideways before they turn bear, and quiet markets expand into trending bull or bear markets. As a trader, you want to be aware of what market typically comes next and plan accordingly.
How to Identify Market Types
While there are numerous ways to identify market types, here is an intuitive model you can follow.
For this, we use two sets of indicators:
– Bollinger bands
– A 7-period and a 3-period Exponential Moving Average (EMA)
These can be applied across any timeframe on any chart. They provide you with an easy-to-use method of identifying the current market type.
Bull Normal Market Types
A bull normal market type can be identified by the price trading above the Bollinger band, while the 3-period moving average is trading above the 7-period.
The Strategy
In a bull normal market type, there are generally two strategies that will be effective:
- Buying dips. You set limit orders at key levels or wait for a pull-back. This is an indication that the trend is going to continue.
- Buying breakouts. You wait for periods of consolidation and then buy breakouts in the direction of the trend.
Bull Volatile Market Types
Bull volatile market types can be identified by large candles trading above the Bollinger bands. These candles will often have long wicks.
The Strategy
In volatile bull market types, it can be tempting to rush in and buy. However, this may not always be the best course of action. Keep in mind that prices can quickly reverse. If you are lucky enough to be in a position that turns into a volatile bull, then keep your stops tight.
Bear Normal Market Types
Bear normal market types can be identified by the price trading below or along with the lower Bollinger band and the 3-period moving average remaining below the 7-period.
The strategy
For a bull normal market type, sell on rallies or breakouts after a period of consolidation.
Bear Volatile Market Types
Bear volatile market types can be identified by the large candles trading outside of the Bollinger band.
The strategy
Similar to the bull volatile market type, the bear volatile market type is a difficult one for entries. However, if you find yourself in one, as you often will, keep your stops tight to guard against the reversal. This will allow you to capture profit if the move continues. It will also allow you to keep hold of most of your profits if it quickly reverses.
Sideways Quiet Market Types
You can identify a sideways quiet market type by the Bollinger Bands tightly coiling around the price.
The Strategy
Breakouts from sideways quiet market types can provide excellent risk/ reward trading opportunities. Be patient and stalk the breakout like a hunter stalking their prey.
Sideways Volatile Market Types
Sideways volatile market types can be identified by expanded Bollinger bands moving sideways and the price contained within the range.
The strategy
There are some excellent trading opportunities for range trades during sideways volatile market types. Wait for the edge of the range to be penetrated and the price to reverse back inside before you place the trade.
What’s next?
Learning to identify the market type and apply the right strategy will significantly impact your trading.
Now, take out your trading plan and note:
- How you will identify the market type
- How you will trade it
Once you turn these notes into regular habits, you should start seeing better results.
