Trading Change and Stability in the Market

Markets are stable and markets are changeable.  What makes markets challenging to trade is that periods of stability, whether they be trends or ranges, give way to shifting periods and vice versa.  Nothing can be quite so painful as becoming anchored in a stable regime and miss the signs that the market is changing.  Similarly, it can be enormously frustrating to anticipate one change after another, only to return to the same old range and regime.

For me, two of the most crucial variables for understanding a market are volumes traded and the standard deviation of price changes.  Volume tells us who is in the market.  A significant shift in volume generally denotes a significant change in the proportion of value and momentum players relative to the number of short-term participants and liquidity providers.  Such shifts create changes in market direction.  Very often, they also create changes in volatility:  the standard deviation of price changes.  

If, over a lookback period, markets are trading with stable volume and volatility, it's a pretty good bet that markets will continue doing what they've been doing.  Reverse engineering the successful trading patterns from the recent, stable past is a good start to finding winning trading strategies for the immediate future.

When the most recent period in the market has been stable, we can break down the market action into a trend component and a cyclical component.  That break down can give us worthwhile clues as to when we want to trade with market action and when we want to fade it.  You keep doing what has worked unless and until you get concrete evidence that volumes and volatility are changing significantly.  During stable periods, it is much more profitable to be trading the patterns that show up in markets in the current regime than to hope for change and try to crystal ball when regimes will end.

Further Reading:  Adapting to the Market's True Clock

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