Market Dynamics

There are many ways to evaluate which direction the market is going and there are many markets and many time-frames that traders are looking at. Some find the fundamental approach work for them - fundamentals try to look at market- and political- and a-political- events and attempt from this perspective to evaluate in which direction the market should be moving. The problem is that should be and where it is moving are often very different directions. For you, as futures trader, where you realize the day to day price difference in your pocket this approach may be problematic, unless you have got very deep pockets!

The technical analyst uses many different tools - RSI and moving averages and Elliot Wave Theory and Fibonacchi and support and resistance and I don't know whatever other crap to try to predict where the market is heading, usually in a much shorter time frame.. (To be fair to the technical gurus out there - your methods are not 'crap' - if it works for you then great, use your tools to your advantage). The problem is the market follows its own head, it goes where it wants to go, regardless of whether a technical indicator said it should now turn around or it was supposed to be "oversold".

The market is actually really simple, it follows a certain set of rules - a law, the Law of Charts. Like nature is following a certain set of rules - the law of nature. We do not try to predict where the market is heading, we just observe what it is doing and we reach accordingly. If it goes up, we buy. If it turns around and drop, we go short.

I look at the markets almost exclusively only on a daily chart. I might zoom out to a weekly chart to get a feeling of likely direction, but for trading, decision making purposes, I use the daily price chart. Look, fundamentals are important - if there is a profound reason why a market should go in a certain direction, I take note of that, I keep it in the back of my head. As for technicals.. I hardly ever use them - I like to read what other guys are saying and I keep up to date with trends, but they are like the fundamentals, something I park in the back of my mind. In the end all that really count is what the market is doing!


Above is a very simplified version of a market. This one is trending down (we leaving it to you to apply the same principles for an uptrending market). This "saw-tooth" behaviour is typical to a healthy market. It goes down, corrects, then continue down, corrects and continue.. Note how it reaches a low (light horizontal line), correct upward from the low, then continue to take out the low, move to a lower low before it corrects again. If it just went down and down and down without every correcting - well we'll be happy that it does, but then there is something wrong, the market is not healthy, we need it to correct, we need this "saw-tooth" behaviour for the market to be "healthy".

OK, the market has made its latest low - at point '1', then corrected to point '2' and it is on its way down again, point '3'. From here on the market will do one of three things (there is no other option):

It will continue to go down, taking out our latest low at point '1' and continue its long-term trend.

It will turn around and go back up, taking out the "high" it made at point '2'. We now have the start of a new "sawtooth" action, this one going up, correcting down, going up, correcting, etc. The trend has reversed. We do not know how long this move will last yet, maybe it is just a slightly bigger correction, maybe it is for real and this is the start of a long-term upwards relationship, we do not know, time will tell.

This is the third option. It goes down, but does not take out our point '1' low, in other words our trend does not continue. Neither does it take out our point '2' to reverse the trend. It just goes up and down and up and down, aimlessly wandering around, seemingly directionless. This "condition" can last for days, weeks at a time. There is just no direction.

This state of affairs will continue until one of two things happens:

It will break out of this range, this channel it caught itself in and continue with the previous trend. In this case this "sideways channel" was nothing more than just another "sawtooth", except this one was flat instead of sloping upwards. We are back into the trend the market was in before this flat section occurred.

OR


It will break up out of the channel, make a correction (point '3') and continue upwards, establishing a new uptrend. (Of course it could from point '2' just go back down to point '1' and resume the up-down-up-down - in that case all that happened is our "channel" just widened, but the principle remains the same!

In short, this is how the market behaves and will always behave - it is the Law by which charts move!!

Let's put it into practice...

Here is a chart of the USD/GBP currency pair for the March 2015 contract:

Do you see it?

You don't..? Allow me...

Do you see it now? The GBP went down in a "sawtooth" motion, making three sideways areas as it moved down. With the third (last sideways) area it breaked upwards out of it, reversing the trend - it may be short-lived though, looks like it is again forming a sideways area..

Here is the March 2015 Gold futures:

This one is making a lot of sudden trend reversals

How do we trade this?

With the trend, every time it continues to move in the direction of the established trend, after a "sawtooth" correction

and here after a sideways period (which is just a special "sawtooth")

With the trend reversal, as soon as it continues in the other direction..

And here after a sideways area

Note that with the trend reversal, we waited for a correction (the first "sawtooth" movement) to show us that the trend has indeed reversed, while in the direction of the trend (down in our case) the moment it continues in the direction of the trend (the sidewys movement was the "sawtooth") we continue with the trend.

It is simple. Nature follows the laws of nature. Charts follow the law of charts. We do not try to predict what the market should be doing! Instead we follow what the market is doing and we just go with it as it does it!