I have a set procedure to analyze a market.I’m a swing trader, so generally I’m looking for an opportunity to buy a break in an up trending market, or sell a rally in a down trending market.If it appears that a trend is failing, I may look to take advantage of that as well.
However, this isn’t where I start my analysis.I first look to see if a market appears ready for a breakout, directional move.I start here because a market that’s set up for a directional move is not necessarily going to break out in the direction of the overall trend!
Let’s look at this for a moment.Market volatility tends to be cyclical.Markets move from periods of high volatility to low, and then back to low volatility.Think about this.A volatile market tends to be either strongly trending, or whipsawing back and forth.A strongly trending market will tend to increasingly push out those on the wrong side of the market, until a market clearing price and equilibrium is reached.A market that is whipsawing back and forth tends to hurt traders on both sides of the market, driving out market participants.
This pattern describes a cyclicality to market volatility, and that cyclicality means that the level of volatility can be predictive of the futures level of volatility. This is important.A low level of market volatility may be predictive of an imminent expansion in volatility. Conversely, high volatility may be predictive of a market consolidation.
A market with low volatility may be described as a “positive feedback system” (for more thorough discussion of positive feedback systems, go here). A market with low volatility may be primed for volatility expansion and a directional move. This is the kind of pattern I look for when looking for breakout setups.
Conversely, a market with high volatility may be described as a “negative feedback system” (for more thorough discussion of negative feedback systems, go here).A market with high volatility may be ready for a decrease in volatility and consolidative trade.
Identifying volatility levels can give you a tipoff as to future market activity, which is the goal of market analysis.To go along with identifying volatility, I developed a trading advisory to exploit these volatility setups.I call this service Trade or Fade, to both identify potential trade setups, and a systematic approach to trade them.For more information on Trade or Fade, visit its web site here. To sign up for a free two week trial and the user’s guide, go here.
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