Why it’s crucial to know your trading environment

MARKETS will usually experience three types of market condition: downtrend, uptrend or ranging. Knowing which trading environment you are in can save you money and time.

This is because the technical analysis tools and systems investors use will act differently depending on the market environment. Working with breakouts, in strong trending markets a sloppy entry might work, as the trend will eventually lift price beyond your entry.

Using the same technique in a flat market, however, you will probably buy at the day’s high and get stopped out at its low. This is frustrating yet sometimes necessary, as there is no easy way to know when volatility will die out. And with no risk, we stand to make no gains.

But we will notice that our average losing streak will extend longer than usual. Many traders continue to trade in this situation, trying to regain their losses – classic revenge trading.

Yet to remedy bad performance, I would suggest taking a break and observing the markets for a few days or weeks, waiting for momentum to pick up. This will keep your power dry for when it matters, and keep you focused. Markets that are trading sideways could be mentally draining.

Another way to go about it is to trade with a longer investment horizon, and use the bigger time frames to pick stop loss and profit targets. This means that we avoid all short-term signals.

A third way is to move onto another market where momentum is already present. Or finally, you could simply embrace low volatility and trade accordingly.

Alejandro Zambrano is a currency strategy analyst at DailyFX.com.