Wednesday, May 13, 2015

Volatility and market exposure

The continuing volatility in the markets over the last few days accounted for another trade yesterday, which was closed for a +3.29R profit. This has now left me with only one trade open.

I'm not too fussed about this lack of exposure at the moment. While trend followers attempt to embrace volatility, sometimes the market conditions, or the price action in stocks you are following,  are such that sitting in cash is the best position to be. And, as I discussed here, being stopped out of your existing positions one by one, with no new positions triggering, should be taken as an early warning sign of possible trouble ahead.

In my own trading, I try and exploit an expansion of volatility in the direction I am looking to trade. In particular, I look for set ups where there has been a contraction in price volatility prior to the entry signal being triggered. And, when that price level is breached, that is when I try to hop on board. Then, hopefully the volatility in the stock will increase as price starts to move out of its consolidation zone and in the direction I am trading. I call this positive volatility.

What I try and avoid is what I refer to as negative volatility - that is, where the volatility increases, but it is applied in a haphazard fashion, with no clear direction in price. That is when the volatility can lead to whipsaws and just price noise. Just look at a chart of the Dow over the last two or months as a good example.

As mentioned in previous blog posts, it is noticeable that quite a few set ups I have been watching have seen price do an about turn and start moving in the opposite direction, or 'churn' in a volatile manner, or attempt to breakout but quickly fail. It is these conditions which can lead to you chewing up your equity. This is where having the patience and discipline to wait for improved conditions will help you.

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