As the temperature outside rises, market volatility continues to decline. The daily ranges are becoming smaller and smaller – which from a day trader’s perspective –means that the opportunities for big intraday moves are becoming less frequent.  This translates (at least for those of us that love volatility) into not much fun. Of course, this could change quickly, and when the ranges do expand again – the proper adjustments have to be made.

In my experience with new traders, I have found that they are often too slow to react to continually changing markets.  Specifically, a day trader must learn to identify early in the session, what type of trading day is unfolding. He should ask himself plenty of questions. Has the market been trending or going sideways?  Is it nearing a major support or resistance level?  Alternatively, are we in a reversal type day (one direction in the morning with a counter move in the afternoon)?  

Once the type of market has been established, the decision making process is somewhat easier. You might ask, why is it easier?  Well, at this point you can elect to trade or stay away. This decision is predicated on how your particular methodology performs in current conditions. If your method has performed well in the current environment, then you should be seeking low-risk trades.  If the present environment is inhospitable to your style of trading, then it is probably best if you stay sidelined.

As an example, your style of trading entails shorting at major resistance, or buying only at important support levels.  If the market is nowhere near any of these price points it is reasonable to expect that you will not have a trade.

Regrettably, newer traders have not gained the necessary experience to distinguish different market conditions.  Another common mistake made by these same traders is implementing methodologies designed for specific market conditions – i.e. trend following, channels, breakouts etc. – in all types of market environments without proper discernment.  As a result in many instances, after a short string of losing trades, a perfectly good system is often discarded prematurely.  When in fact, the issue is not with the method, but with the person implementing it.  The lesson here is to learn which asset class and style of trading, works best for you, and only you. Once you have figured it out, trading will become fun and more importantly, perhaps more profitable!

Let’s shift our discussion over to the current market. This week, both the VIX (volatility index) and volume on the major exchanges made yearly lows. Previously, I have noted the VIX as a measure of both fear and complacency. Obviously, the latter is what we have working now. What will break this psychology is anyone’s guess.  Perhaps the decisive breach of a major technical level will do it, or a fundamental reassessment of current economic conditions may do the trick. Then again, it just may take a change in perception about risk. Nonetheless, the market has a way of baffling most people at major turning points.

A recent example of how the market tends to fool the majority is the failed “head and shoulders” formation on the S&P, which received a lot of mention in the financial media. This chart illustrates this formation in the E-mini S&P. Everyone “assumed” that the pattern would play out. Others may have drawn the neckline across the first minor low, or some other variations.  


This is an excerpt from Aug 2009 issue of Trader's Journal.