You know the saying “the definition of insanity is doing the same thing and expecting different results”?
Van Tharp (A Market Wizard – yep, they are a real thing) has a new definition for traders:
“Expecting the same system to work in all market types is the definition of insanity”
So, as a follow up to my previous post: How to trade what’s in-front of you, I will teach you the method I use to identify Forex market types.
Once you identify the market type, you can then apply a strategy to that market type, stay out of it, or reduce your position size if your system does not work well in that market type.
There are six main market types:
- Bull normal
- Bull volatile
- Bear normal
- Bear volatile
- Sideways quiet
- Sideways volatile
There are also a multitude of variations of these market types (up to 26 according to Van).
Here you can see a few of them on the USD/JPY weekly chart.
My Market Type Identification Tool
To identify Forex market types, I like to use the Bollinger bands. I use the 20 period Bollinger bands with 2 standard deviations. I also sometimes use the 10 period Bollinger bands with 2 standard deviations.
And I do it across multiple timeframes.
One of the keys to trading what is in-front of you is to be flexible and situational in how and when you apply the tools you have.
I will frequently stalk an entry on the hourly chart, when the market type has been defined on the weekly or daily or 4 hour chart.
The reason I use the Bollinger bands is it gives me a nice visual representation of both the trend and the volatility of the current market.
When the price is trending in the direction of the band, it is a bull or bear market. If it’s inside the bands it’s a sideways market. If the bands are, or have, expanded it’s volatile. If you are contracted it’s quite.
Let’s look at an example for each of the market types above.
To identify a bull normal market type, look for the price to be trending with the upper band, and above the mid Bollinger band.
In a bull volatile market type, you will see long bullish bars or candles when the price trends with the upper band. The price may frequently cross above the upper band itself.
Bear normal is the opposite of bull normal. The price trends with the lower bands and remains below the mid band.
Bear volatile is the opposite of bull volatile. You will see long bearish bars develop that sometimes cross below the lower band
In a sideways volatile market type, the bands are wide and there is large sideways price movement.
In a sideways quiet market type the bands contract and the price forms a tight range.
Trading the right way for the current market type is critical
If you are not trading the market type in-front of you then Van is right, you are practicing trading insanity.
There are a lot more subtleties around market types, which I will go into in future posts. In the meantime you can start by defining the market type on your favourite currency pairs.
There is also a detailed lesson on market types in The Advanced Forex Course for Smart Traders (you get free access).
About the Author
Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders. He is a key team member at premium FX services provider www.fxww.com and part owner of Forex Signal Provider www.fxrenew.com (You can get a free trial). If you like Sam’s writing you can subscribe to his newsletter for free.
This post was first published here.