One of the main reasons traders might suffer heavy losses is an inability to change strategies when the market changes.
Typically, a losing trader doesn't recognise a change in the market quickly enough, probably because they've focused only on short-term profits. Then, as losses continue, they increase position sizes and ignore their trading plan and its rules, further increasing their losses.
In contrast, successful traders are aware that the market is constantly changing and see this as an opportunity rather than an obstacle to making money. For example, when the market moves more than it usually does, they widen targets and stop losses, aiming for better profits. In other words, they trade flexibly in response to market changes.
1. Trends are triggers
There are three market environments: uptrend, downtrend and sideways. Prices continue to move through these three market environments repeatedly.
Market prices can be affected by support and resistance, chart patterns, important news and economic indicator releases, etc., which all together form the next trend. So, once you understand the current market environment and feel confident to predict what's to come, you can trade according to your trading plan.
When the market environment changes, your strategies may no longer work, so you need to know when to change your trading strategy.
✓ Adjusting your strategy
When the trading range narrows, narrow both your targets and stops.
When the trading range widens, widen both your targets and stops.
2. Volatility is a trigger
Volatility is a measurement of how much the market has moved over a period of time. Understanding volatility is a necessary part of determining targets and stops.
A market with 50 pips of volatility in a day can rapidly change to 100 pips of volatility. Volatility, like trends, can be triggered by prices, chart patterns, important news and closely followed economic indicators. So it's always good to compare average volatility with the current volatility level to gauge whether the market environment is quieter or more intense than usual, so you can adapt to that.
So why do markets change in this way?
Reasons for market changes
News and events which quickly affect traders' thinking can have a significant impact on the market. For example, the publication of key economic indicators, statements by central bank governors, and news about wars or political changes can quickly change market sentiment and volatility. Knowing the characteristics of the currency or stock you are trading and the kind of news which affects that market will help you focus on what's important.
2. Chart analysis
You can see changes in the state of the market depending on whether it is above an important high or moving average or below an important low or moving average. Markets can change rapidly from range to trend and from trend to the range, triggered by indicator signs.
Technical indicators such as Bollinger Bands, RSI and MACD can be useful, but for chart analysis, the highs, lows and moving average slopes are fundamentally important.
Sentiment describes the state of mind of traders. Based on chart analysis and various news items, sentiment is the cumulative expectation of all traders for future price movements and at times can drive price direction by itself, in the absence of news and events.
How to handle market changes
In order to deal with a constantly changing market, the best trade preparation is to set clear risk management rules. That way you can accept small losses without widening your stop. If losses are kept small, you can still adapt your strategy to the new market environment and make new trades.
2. Market Awareness
By focusing on a small number of markets, you'll gain a better understanding of how those markets operate. Watching out for news and reflecting on why the market is moving also gives you insight into what other traders are monitoring and reacting to. By doing this, you will better understand how to spot market changes and amend your strategy for a better chance of profitable trading.
Remember, if you keep trading notes, you'll more easily identify market changes by noticing when prices move in a similar pattern to the past, and react accordingly to your advantage
3. Having different strategies
Having both trending and ranging strategies ready to deploy allows you to change the way you trade when the market does change. A single strategy will not always work well, but having a group of strategies can help you to be profitable in each market environment.