Understanding Market Structure

February 19, 2006 by Trader Rich

There is another decent article in Stock & Commodities magazine regarding market structures.

Sometimes I neglect to identify the underlying market structure before entering a trade. I’m hoping this post will help you and I.

This article identifies 4 market states:

1. High directionality - low volatility : prices moving steadily up/down with no or little reaction or correction. Trend following systems work fine in this scenario and oscillators will continuously give false signals.

2. High directionality - high volatility : trend is well-defined and corrections are deep and volatile. This scenario favors swing traders and counter-trend traders.

3. Low directionality - low volatility : no or little direction and moderate volatility. This is a very difficult environment to trade in and traders should wait for a new trend to ultimately emerge.

4. Low directionality - high volatility : no or little direction but deep swings. This market state favors swing, counter-trend, and short-term traders.

Click Read More to Continue reading.

In addition to identifying market states, 4 different market phases can also be identified:

1. Trend - Contraction : the market is taking a breather. You want to enter a trade in the direction of the trend when the market takes a breather. The probability of a new price surge is high.

2. Trend - Expansion : when the market enters this phase, you will want to already be in the market. You should apply patterns to close the trade during the volatility expansion.

3. Congestion - Expansion : you don’t want to be any part of this market. You would be entering during high-risk levels. If anything, you can try to apply fading techniques.

4. Congestion - Contraction : This is an area that could have big moves. The market is contracting with no interest from the crowd. Entering here can have low risk, high reward opportunities.

You can read a snippet of this article at http://www.traders.com/Documentation/FEEDbk_docs/Abstracts_new/Pezutti/pezutti.html
or buy the March issue of Stock & Commodities magazine.

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