How To Trade In A Market That Is Flat Lining
At times, we see the financial markets exhibit seasonal patterns different from the norm.
There is the “Presidential Election Cycle”, the “Santa Claus Rally” as well as the dreaded “Summer Doldrums”, each of which can have drastic effects on market behavior.
In this blog post I will concentrate on the effect the “Doldrums” have on the markets, which can in turn directly influence your trading results.
The actual word “doldrum” means a state of inactivity, mild depression, listlessness, or stagnation and is an old maritime term from the 18th century used to refer to long periods of calm, windless seas. These were periods where the typical ocean winds completely disappeared due to low-pressure zones around the equator. These stagnant conditions trapped sailboats and sailors out in the middle of the ocean for days and weeks on end… floating adrift. The only thing sailors could do was be patient and wait for the normal winds to pick up again.
When the market gets stuck in the doldrums, we see similar periods of stagnation leading to Dull Market Conditions. Price action slows down, volumes drop off, overall market movement becomes extremely choppy, strong trending action becomes a rarity and trade setups of all types experience a much higher failure rate. Basically there is a decrease in conviction and an increase in randomness throwing everything out of whack.
While this form of market stagnation typically appears during the summer months, the market can go into the doldrums at any time of the year. Recently, we have had a perfect storm of events, that in rapid succession has brought about another severe phase of market doldrums. Beginning with the Futures Symbol Contract Rollover, on a Thursday, followed by a Triple Witching Options Expiration Friday, and a Janet Yellen Fed Meeting the succeeding week, next the Brussels Terrorist Attacks, ending with, last but not least a Good Friday Market holiday. That is a lot of events to pack into a short time which caused the market to grind to a near halt and flatline for nearly 3 weeks.
In addition, during the same time-span, we have a spate of somewhat rare technical market conditions occurring. First, the general markets find themselves trapped around key long term moving averages which can tend to freeze broad price action. Some of the major indexes have become hung up on not only the 200 day SMA, but the 500 day moving average as well. Also the S&P is hovering right at the 61.8% Fibonacci Retracement Level from the macro June-February decline. If we pop over to the Weekly chart we see that the S&P is stuck near it’s 50 week moving average. Finally, tack on that this mature bull market appears to be getting tired as it has retraced quite a ways back up into major overhead resistance levels covering the previous 8 months. Put all this together in a short amount of time you will begin to understand how the market can clam up and become a jittery, frustrating, non-trending, sideways moving glue trap with little conviction to help it escape one way or the other.
How Does This Affect Trading?
It is well known that stagnant, flat-lining markets make profitable trading extremely difficult. When price action is stuck in the doldrums, liquidity and momentum all but dry up and trading gets real tough. Win ratios drop off drastically and the distance to your trade targets shrink as trending behavior becomes a rarity. All of your favorite trading strategies and market-timing techniques suddenly seem to stop working. (The frustrating thing is that the trade triggers to get you into trades continue to work… just not the follow-through.) What looks like a beautiful entry setup with great potential ends up fizziling and quickly hitting your full stop. Losses mount as more full stops get hit – and you start to die the death from a thousand cuts. During the doldrums hundreds and thousands of trade setups appear and then disappear and reappear luring in waves of traders who will go on to become canon fodder for the market as they incur one stop out after another.
So What Is Going On?
Whether you are a system trader or a discretionary trader or even a non-thinking automated trading bot… you will have a tough time navigating a super dull market. Here’s why. All trade setups presuppose some form of rhythmic price movement after an entry is made. The entire concept of speculation is to place a bet at one price in the hopes it will go to another price. The problem is that during the doldrums the normal rhythmic waves of movement that we grow accustomed to trading off of begin to disintegrate – becoming unpredictable and virtually impossible to work with. In addition to the increased degree of randomness, the distances that price will move over a given period of time drop to such small tolerances that it gets quite challenging to pull a decent profit out of a trade.
The Bottom Line Is That The Market Conditions Are Just Not Conducive To Making Money.
I have often compared Futures Day Trading to various aspects of playing sports. As a matter of fact, the more you start thinking of trading as another form of sport (albeit serious sport), the easier it is to understand how odds play into the trading game and affect your probabilities. Poor conditions can hamper other sports as well. For instance you could have the newest set of high tech skis and the best Swiss ski coach… but if there is no snow on the mountain… the conditions are not favorable for skiing. Period. Better to sit in the lodge and drink hot cocoa. You can have the radest new surf board on the beach… and the best Hawaiian surf instructor… no waves.. no surfing. Not a thing you can do about it except sit on shore and wait. These are 2 self-evident sports examples demonstrating how you won’t be able to perform at certain times if the conditions are not conducive to your activity.
When the market is stuck in the doldrums, its identical to one of these no snow, no waves scenarios. The proper conditions are just not there for you to win and if you are going to attempt to push through and trade the market anyway expect a serious and tricky challenge at your hands. Attempting to aggressively force trading through the doldrums has caused many an experienced trader to give back weeks worth of hard fought gains… and caused newbie traders to wipe out their accounts forcing them to quit altogether or abandon the strategy they are using in search of yet another new “Perfect Trading System” which of course doesn’t exist.
Some traders attempt to use the Average Directional Index or ADX Indicator to tell them when the market is dull and when the market is trending. Most watch for a 14 period ADX line to pass above a 20 reading on the indicator to let them know when they can trade, but I have never found this to work especially good in day trading. While the ADX might show when a swing trading stock has started a new 3 week uptrend, the indicator for day trading seems to get caught up in all the typical intra-day whip-saw which is the problem in the first place. You will also see that some trades by random luck will work even though the indicator is below 20 and other trades fail and hit stops even though the indicator is above 20, so the ADX unfortunately is not a quick fix for trading a dull market.
So What Is A Trader To Do?
The only sure-fire method is STOP TRADING COMPLETELY. You simply avoid all the risk by sitting it out by not exposing your capital during the doldrums. Sometimes when the doldrums occur around the holidays, this might be a perfect time to take a break, recharge your batteries.. spend time with your family and enjoy the holiday season. You may find the break does you good. However there are times in the year where stagnant market doldrums creep in and start to rain on our parade and we don’t exactly want to take a break from trading. So if this is the situation, how do we adapt to navigate the dull market safely and not get chopped to bits?
Here Are Some Basic Tips:
During the doldrums the market has less participation, less aggression, less conviction, so the first thing is to adapt your trading to match these lower levels of expectation.
Tip #1. Reduce Your Position Sizes: If you are getting stopped out more than normal, you can reduce the drawdown simply by lowering the number of contracts you trade. If you are a 2 contract trader you don’t have much downsizing room to go.. but dropping down to 1 contract on trades for a while can reduce the sting. If you trade larger lot sizes things are easier. For instance if you are a 10 lot trader.. a 2 point stop-out on one failed trade is -$1000. But by scaling all the way back down to 2 contracts you can handle 5 losing trades in a row for the same risk. This helps reduce the drawdown over the series.
Tip #2. Lower Your Targets: During the doldrums, market participants are nervous and less committed which reflects itself in less follow through on price moves. If you are normally shooting for 4 point targets cut your expectations in half and go for 2 point exits. If you normally shoot for 1 point delta targets on half your position, … reduce that to 3 ticks. These small tweaks can have you exiting with a greater frequency of winners during tough market conditions and increase your bottom line.
Tip #3. Tighten Your Stops: During the doldrums, price action becomes more reactionary, random, and directionless. Since more trades are likely to fail you can reduce the overall drawdown by reducing the amount of loss on each trade. If you normally trade with a 2 point initial stop, reduce that to 1.5 points. You can also be more aggressive about tightening your stop on trades that don’t appear to be getting off the launch pad relatively quickly. In this way you can head off lots of stinkers that are just going to fizzle and fail and cost you money. You can also attempt to scratch more of your trades at Break-even, getting out at your entry price on trades that don’t look like they are going to end up working after them a fair shot. In active markets, good trades tend to take off quickly in your favor and away from the direction of your stop and you can go for days on end without suffering a full stop-out. In super dull-chop markets, every trade attempt you make can lead to a full stop-out and you can quickly find yourself hitting max drawdown.
Tip #4. Trade Less Overall: When the markets go into the dumpster and trades quit working, if you attempt your normal quota of entries per day, you can expect to introduce a higher percentage of losers into the mix of your historical win/loss ratio. So when the going gets tough, simply trade LESS. You can do this in several different ways. Start by taking some days off from live trade. Mondays and Fridays are statistically the worst days of the week to trade, so you can begin by NOT trading those days, leaving just 3 days, Tuesday, Wednesday, and Thursday on the schedule. I would recommend trading Mondays on SIM as a warm up day and a way to get the pulse of the market at the beginning of the week, and then just taking Friday off completely as a rest day. If you normally average 5 trades per day, this reduces your weekly entry attempts by 10 right off the bat. The second thing you can do, is trade less each day. Instead of jumping into the market during the first hour of the session each day like a kid in a candy store… sit the first hour out patiently and watch how the market is behaving.. then start trading if the market looks like it has potential. Skipping the first hour each day during the doldrums can keep you out of 2-3 early morning stinkers that fail due to the agitated volatility we often see right after the open. You can even start trading on SIM each day until you start seeing trades work and only then go live. If you want to be really strict, only limit yourself to 2 trade attempts per day regardless of whether you win or lose. 2 stops, you quit, 2 wins, quit. 1 win, 1 stop. quit. As far as the entire week goes, if you have 2 losing days in a row, STOP live trade for the remainder of the week.
Tip #5. Reduce Max Daily Drawdown Levels: I normally recommend that 2 contract traders have a max draw-down limit of negative 6 ES points on any given trading day. If you hit this level of drawdown at any point in the session you quit for the remainder of the day… no questions asked. You can reduce your max-down by a few points and this will help you trade less as well by forcing you to quit earlier. Instead of a max drawdown of 6 ES points per day, drop it to 4 points. Everything works together to help reduce your exposure and risk during a lousy market. If you are trading smaller size, using slightly tighter stops, taking quicker targets, will all help to avoid the large drawdowns in the first place. Lowering the daily cutoff level helps as well.
The Bottom Line
The market doesn’t always behave like we want it to. It can and does go into long, protracted dull periods several times a year, which can make profitable trading next to impossible. This is just a harsh reality that traders must accept if they are going to be able to go on to become successful over the long run. Attempting to aggressively force your normal trading style on the market during the doldrums can cause even the most experienced of traders to give back weeks worth of hard fought gains or cause a newbie trader to blow out their entire account – forcing them to quit. Or several unsuccessful weeks of aggressive trading during the doldrums, can cause a trader to want to abandon using, what in reality is a robust and promising strategy, only to begin the search anew for yet another “Perfect Trading System”, which of course doesn’t exist, in effect, throwing the baby out with the bath water.
The truth is that trading can be just as risky as you allow it to be. You can never eliminate every degree of danger in trading, but you can put curbs on it. When trading gets super tough during a dead market, ABSTINENCE, not AGGRESSION is the Key. Continue to Trade on SIM mode which will help you keep your finger on the pulse of the market… so that you are ready for when price action does come back with a vengeance. Your goal is to still be around when it does.
How do you know when the market doldrums are over? Trades Start Working Again.