Originally posted by James Harte on LittleFish FX
In our “Moving Averages & Bollinger Bands” webinar we discussed how Bollinger Bands can be useful in giving us information about the underlying state of the market and how we can use that information to develop trading opportunities. Following on from that I want to expand this idea and take a look at the different market types we generally find. No market is trending or ranging permanently, price action always moves through different conditions and even within a trending phase or a ranging phase the price action can vary greatly. Understanding the conditions that suit your strategy best and the conditions that cause your strategy problems is an important learning curve in trading and begins with first learning to understand the different market types present.
The Different Market Types
Classifying the various market types we see is an idea that features prominently in the work of eminent trading psychologist and coach Dr. Van Tharp. Although his work is particularly detailed and features around 25 distinct market types the main market types to understand and learn to identify are as follows:
- Bull Normal
Bull normal is an upward moving market that has steady momentum behind it and is generally bought on dips, with price action displaying the typical “staircase” pattern that we get when we see higher highs, higher lows, higher highs, etc. This market is characterized by steady advances to the upside, followed by brief retracements and consolidation before further upside manifests.
- Bull Volatile
Bull volatile is an upward moving market that has rapidly accelerating momentum behind it and features large bullish candles. This market is characterized by its explosive movement offering very little retracement and only particularly brief pauses which only register on the lower time-frames.
- Bear Normal
Bear normal is a downward moving market that has steady momentum behind it and is generally sold on rallies, with price action displaying the typical “down the stairs” pattern that we get when we see lower lows, lower highs, lower lows. This market is characterised by steady advances to the downside followed by brief retracement higher and consolidation before further downside manifests.
- Bear Volatile
Bear volatile is a downward moving market that has rapidly accelerating momentum behind it and features large bearish candles. This market is characterized by its explosive movement offering very little retracement and only particularly brief pauses which only register on the lower time-frames.
- Sideways Quiet
Sideways quiet is a ranging market which is very low volume and generally directionless though sometimes features a very slight bullish or bearish drift. This market is characterised by its very shallow and choppy trading range and is generally comprised of many short candles indicating the lack of movement per session.
- Sideways Volatile
Sideways volatile is a ranging market which is much higher volume and though direction-less, can also feature a slight bullish or bearish drift. This market is characterized by its very large rotations between areas of resistance and support. As with sideways quiet, the range is lacking in direction but is of a much larger scale due to the volume behind the moves.
In the chart above you can see an example of each of these different market types. Let’s take a look more closely at how we define and identify each individual type.
Top Tip For Identifying Different Market Types
Once you’ve put in enough screen time, you should become pretty good at identifying the different market types although there will always be times when it is difficult to clarify conditions. However, one tool that you can use immediately to really help you in classifying the market is the Bollinger Bands indicator. The information given on both direction and volatility make this indicator highly effective in this task.
In the example above we can see the same chart but with Bollinger Bands applied. Notice how the Bollinger Bands perfectly represent the various market types and make it much easier to pick them out? This is a great time-saving tool to use and can really help build your ability to identify different market types.
So there you have it, the six main market types that generally define the various states you will find. Now you know the market types present; you need to know what to do with them.
Using Market Types To Your Advantage
As we mentioned earlier, knowing the conditions that best suit your strategy and the conditions that challenge it most, is an important step to success because if you can become adept at maximising the opportunity when conditions are favourable and scaling back risk when conditions are adverse, you can really enhance your returns. To effectively operate in this manner it is important to understand the strategy types that work best in different market conditions.
When the market is trending upward and displaying frequent retracements we want to look to buy on dips back into key support or buy on breakouts above recent highs. Generally works best on lower time frames. So where we establish a daily Bull Normal market, we can drop down on to the Hourly and look to buy dips or breakouts. Stops need to be kept wide enough to allow for retracements and especially on buying breakouts; traders should avoid moving to break even until the breakout zone has been tested as this is a common mistake many traders make and means them getting shaken out just before price takes off. In these conditions, we shouldn’t be looking to fade resistance as it is a low probability trade, against the trend.
Bull volatile can be a tricky market to gain entry to as generally retracement are few and far between and price tends not to test broken former resistance. In these conditions we are best to play simple breakouts with a tight stop, looking to catch the momentum. Again use lower time-frames to highlight resistance areas and enter as price breaks through. Attempting to fade these moves is an extremely high risk and should be avoided.
When market is trending downward and displaying frequent retracements we want to look to sell on rallies into key resistance or sell on breakdowns below recent lows. Generally works best on lower time frames. So where we establish a daily Bear Normal market, we can drop down on to the Hourly and look to sell rallies or break-downs. Stops need to be kept wide enough to allow for retracements and especially on selling breakdowns, traders should avoid moving to break even until the breakout zone has been tested as this is a common mistake many traders make and means them getting shaken out just before price takes off In these conditions we shouldn’t be looking to fade support as it is a low probability trade, against the trend.
Bear Volatile can be a tricky market to gain entry to as generally retracements are few and far between, and price tends not to test broken former support. In these conditions we are best to play simple breakdown strategies with a tight stop, looking to catch momentum. Again use lower time-frames to highlight support areas and enter as price breaks through. Attempting to fade these moves is an extremely high risk and should be avoided.
Sideways Quiet is a particularly boring and low opportunity market as the lack of momentum means the range is very shallow and so even a typical range-reversal strategy, whereby we look to fade support and resistance, tends to be low yielding as there is simply not enough movement to profit from. When conditions are like this, it is best to allow the range to develop and mature and wait to play the breakout. Beware false breakouts though as these can be quite common in these conditions and so only trade candle closes as these give more weight to the breakout.
Sideways Volatile can be a really profitable market for those who know how to trade it correctly. With price essentially just rotating back and forth between support and resistance areas there is ample opportunity to operate a range-reversal strategy and, unlike sideways quiet, because the range is much wider due to higher volume there is worthy profit on the table.between support and resistance areas. As volume is higher in these conditions and momentum is built up, stops need to be wide enough to cope with price breaking support and resistance as often in these conditions we see the exhaustion in these areas where price spikes through only to then reverse sharply.
Pull up a chart and try to identify the various market types we’ve discussed. If you can do it without the use of Bollinger bands, that’s great but if you need to use Bollinger Bands then no problem . Spend some time looking over different charts and highlighting examples then look to some recent price action across various charts and note down which market type you think the price is in and how you expect it to react based on your analysis.
You might be surprised at how quickly you become adept at accurately identifying the various market types and anticipating how price will behave. From there you have a solid foundation to start building trading ideas and exploiting opportunities. Remember, as with all trading strategies and methods it always pays to wait for the clearest setups. If you are struggling to identify a market type, simply move onto another chart. There will be times when markets are transitioning between different types, and it can be hard to identify trading conditions. Simply wait until the conditions become clear and in the meantime look elsewhere for charts which are clearly displaying a particular market type and offer cleaner opportunities.