She Moves In Mysterious Ways

How many different ways can a market move?

At first glance, the answer seems binary: Markets can move in one of two directions, up or down. Work out (or just guess) the direction and it is off to the Hamptons.

Think about it for slightly longer, and be slightly less flippant, and you might realise that markets can move in three directions: up, down or sideways. The market is not always trending, and can spend considerable periods of time without any real direction (see Josh Brown on Middles).

That is true, but still unsophisticated.  It matters what timeframe you are talking about: a market could be downtrending intra-day, stuck within a 4 week congestion range that is part of a multi-year bull trend. When discussing the market condition, it is important to identify the time-frame under consideration.

It also matters whether the market is moving steadily or violently i.e. if it is volatile or calm. Market volatility is not constant, and that can have a considerable impact on your psychology and success.

Within any given timeframe, I identify six ways that a market can move:

  • Up in a steady manner
  • Down in a steady manner
  • Sideways in a steady manner
  • Up in a volatile manner
  • Down in a volatile manner
  • Sideways in a volatile manner

Each of these market conditions feels very different to trade. Different trading strategies perform better or worse under different conditions. Markets with higher volatility are harder to trade: even if you call a trend correctly, there is a higher chance that you will be whipsawed out of your position. It is hard to make any money at all in steadily sideways markets, while mean-reversion and range-trading strategies can work well in volatile but ultimately directionless markets.

Sometimes you will hear different markets classified by their “usual” behaviour e.g. commodities “tend to trend strongly”, stocks “tend to mean revert”. Different assets are viewed as more volatile or riskier than others. Just as important, though, is recognizing that all markets cycle through the six different states over time: Soybeans might be more volatile than Treasury Bonds overall, but it is just as interesting that Soybeans were more volatile in June than they were in April. Volatility is nothing if not cyclical.

It is important to know how your trading strategy and style works under each type of market action. It is unlikely that your personality will be equally comfortable trading all different market conditions. Perhaps you can design some filters that sit you out when conditions are unfavorable to you, or perhaps you just have to accept that there will be a series of losses until the wind starts blowing your way.

Market movement is more subtle than simply “up or down”, and volatility is itself volatile. I normally avoid metaphors like the plague, but the wind is not always blowing from the same direction, nor at the same speed.

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1 Comment

  1. Tops, Bottoms and Middles | The Reformed Broker

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