Tuesday, June 1, 2010

Are there any Bad Market Conditions in Forex Trading ?

It is not uncommon for traders to refer to certain trading conditions as being "bad". In particular, during the past few weeks I have heard people calling current EUR/USD market conditions this way. Why do traders refer to some conditions as bad and to others as being good ? Is there an inherent quality of a given market that makes it good or bad to trade ? On today's post I will try to address this issue and explain to new traders why you cannot call any given market conditions good or bad since this makes no overall sense. I will attempt to explain why traders look into when they talk about market "quality" and why there is simply no reason why certain systems should be stopped under different market conditions as the future development of the market is never known with certainty. I will also highlight some example about the way in which this judgment is costly and many times makes traders lose significant opportunities due to the overall misconception that the market can be "bad".

First of all, we must understand the way in which traders look at market conditions and why some traders - usually inexperienced ones (no offense :o)!!) - judge the market's quality by calling it good or bad. The conception usually arises from the use of mechanical trading systems. When a mechanical system starts to fail under a given market condition, users of a system usually call the current market conditions "bad" and stop trading this mechanical system because it simply "doesn't work" around current market conditions.

There are several wrong things about this approach. Certainly we can say that market conditions were bad for a given trading system in the sense that it had a bad trading week, month, year, etc but we cannot know if future market conditions will or will not be favorable for a system. What I am saying here is simply that the fact that we cannot predict the future makes us unable to judge the currently developing market conditions as we have no idea of how the market will behave with good certainty. Users of a given mechanical system that stop trading it during "bad" market conditions may be surprised when they miss substantial periods of profitability due to their deductions based on past trading.

An example of such a case is easily taken from most long term profitable systems. For example, a 1 month losing period may mean that market conditions were bad but to stop trading the system could mean that a very profitable period would be lost as market conditions develop. When people wait for market conditions to improve they may start trading their system when a good period of profitability has already passed. A real life example showing this can be seen with the Ayotl trading system. The system had some unprofitable trades in February and March but if you had stopped trading the system in April you would have lost an entry that granted a profitable trade of nearly 3000 pips, showing that although you can judge the quality of market conditions after they happen, attempting to forecast future conditions and modifying an automated trading system's behavior this way is nothing but detrimental.

In the end, in my opinion it simply makes no sense to attempt to judge the quality of developing market conditions as no one truly knows the way in which the market will develop. The best thing you can do is to build a trading system with limited market exposure that attempts to minimize loses when market conditions are unfavorable and cash on the market when market conditions allow it. In the end, the ability of a trading system to adapt to changes in market conditions and minimize its loses will allow you to trade it along very varied market conditions with confidence that your system will be prepared. Attempting to judge the quality of conditions that have not developed by calling them "good or bad" before they happen does not have a place in mechanical trading. My advice is to focus on limiting the market exposure of your trading system and increasing its adaptability.

If you would like to learn more about mechanical trading and how you too can build your own long term profitable systems based on sound trading tactics please consider buying my ebook on automated trading or joining Asirikuy to receive all ebook purchase benefits, weekly updates, check the live accounts I am running with several expert advisors and get in the road towards long term success in the forex market using automated trading systems. I hope you enjoyed the article !

4 comments:

C. Smith said...

Daniel-

I think the more volatile a market, the "better" it is for trading.

Take the Average True Range (ATR) of a currency pair and compare it to historical values to determine if the pair is above or below its historical mean. For example EUR/USD is at a 10-month high in terms of ATR and I think this is a good for currency traders.

Same goes for futures, equities, options, more volatility is better in my humble opinion anyway.

While on the topic, check out the way EUR/USD took a brief dip below the recent low at 1.2150, just to snap back above that resistance point.

Interested if you've done any investigations for EA's that trade that type of price action.

Let us know any comments and thanks.

Chris

Daniel said...

Hello Chris,

Thank you for your comment :o) Definitely I believe that volatility has nothing to do with the quality of trading conditions. Merely because you don't need wide movements to profit since - in forex in particular- leverage allows profit from low volatility conditions. Volatility adapted trading systems reflect this, they trade small when the market moves wide, trade large when the market moves small, achieving the same profits/loses and adapting their technique against the market.

What I intended to show here is that you simply cannot judge the quality of future conditions and therefore you can only hope to reduce loses under unfavorable conditions which may appear unpredictably, the same way as favorable market conditions.

Regarding the fake breakout... Definitely a nightmare for Asirikuy breakout systems, several of them took loses on that retracement but well, it is their market exposure. As all systems, breakout systems have loses and they take them when this type of thing happens. However when they took their trade, it certainly looked like a continuation ;o)It is a matter of probability and a matter of coming out ahead after a statistically significant period of time.

Thank you very much again for your comment Chris :o)I am glad that you are reading my content almost daily !

Best Regards,

Daniel

Unknown said...

Hi Daniel,
first of all, excuse me for my bad english. i'm italian and don't speak english wery well.
After i read your article on Currency Magazine, i started reading your posts. I think they are very interesting and good.

with regard to this post, i agree with Van Tharp who says that you have to know what is your expectancy in different market condition. I agree with you, the words Bad or Good hasn't sense. But if you know how is the behavior of your systems in the same market condition can help you improve your overall performance.
Don't you think?
Thanks. Andrea.

Daniel said...

Hello Andrea,

Thank you very much for your comment :o) I understand why what you say seems to make sense : you know how your system performs under different conditions so you are able to know when to trade or not to trade it.

However the problem is that you may know that your system doesn't work under A or B but you simply don't know when A or B will come. If you want to avoid B then you need B to develop before you can remove your system and even if you do then there is the probability that A will develop so you are playing a game of chance (because you simply don't know the future, even if B developed it doesn't mean that it will continue).

Definitely I think that market conditions are different and that playing with when a system can or cannot be profitable isn't possible in an accurate fashion since the future is simply not known and the chances you take by removing your system are just as big as the chances you take by letting it run.

I hope this further explains my point Andrea. Thank you very much again for your comment :o)

Best Regards,

Daniel

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