Forex market is a decentralised global marketplace for trading foreign currency. It is an OTC (over-the-counter) market and it dictates the foreign exchange rates. This is the largest trading market in the world with low transaction costs, high leverage, and extreme transparency. You just need an internet connection to open a foreign currency trading account and you are ready for forex trading from anywhere and at any time.
Forex trading is quite complicated and unpredictable. Every trader looks for a system that can give him consistent results every week with limited drawdown and an upward moving equity curve. Often traders get frustrated or end in losses in a quest to gain profits. To get a firm hold on this financial platform, you first need to gain knowledge about the forex trading system.
Welcome back to class – dear students
However, at the same time, you must also understand that the same system does not work in all market types. Market type in forex is the various stages through which a market moves. The concept was popularised by psychologist and trading coach Van Tharp. According to him, it is sheer foolishness to expect one system to work in all conditions. To let a system work in any market condition, you must first define the market type, and accordingly, the system will give an edge to that specific market type.
According to Tharp, there are several market types. However, here we will learn about the six main types.
- Bull Normal
- Bull Volatile
- Bear Normal
- Bear Volatile
- Sideways Quiet
- Sideways Volatile
You can notice these market types if you will go through the price chart of the forex system. You will see that currency pairs show continuous movement. At times, it trends nicely, while at other times, it is volatile.
Even after being designed by trained traders, some of your forex software fails because they are mostly designed for one market type. One system cannot work for all market types. You must first identify the market type and then apply that system to that type to gain maximum benefits in forex trading.
How Can You Identify Different Market Types?
You just need to look at the chart to identify the forex market types. And it is not difficult at all.
- Bull normal – If the market is going up smoothly
- Bear normal – If the market is going down smoothly at a low pace
- Bull volatile – If the market goes up rapidly
- Bear volatile – If the market goes down rapidly
- Sideways quiet – If the price oscillates between support and resistance levels and the range is tight.
- Sideways volatile – If the price oscillates between support and resistance lines and the range is wide.
If you are aware enough, you can identify the current market type and notice when there is a change in that market type. To identify the market type, you can also take the help of a tool i.e. Bollinger Bands.
How To Identify Forex Market Types With Bollinger Bands?
These bands were developed by John Bollinger. In these bands, you will find an envelope that is plotted against a standard deviation level that is above and below the simple moving average of the price. As the band distance is based on standard deviation, it adjusts to volatility swings in the original price. So, you can say that it is a volatility-based indicator. The technique is quite simple. Take a chart and apply Bollinger Bands.
When the band’s contract, it indicates that the market type is normal or quiet. Expanding bands indicate market volatility. Bollinger bands also help you to identify direction. If you notice the price bouncing on either side of the band, it is the sideways market. If it hugs either the upper or lower band, it is either a bull or bear market type.
Understanding The Market Type Transitions
From the Bollinger bands, you understood how to notice the market types. However, the next step is to understand the transition of a market type in another. In any market, first, the flow of price and ebb goes with human emotion. However, it soon changes into other types. If you become smart enough to understand this transition, you can have a better edge.
For example, normally, a sideways volatile settles into sideways quiet and then transits into a strong bull. If you know that bull volatile ends in bear volatile, you can plan accordingly. In the same manner, you must know that a sideways quiet breaks into a bull or a bear.
As forex trading is a statistical game, it is important to know these different probabilities.
Which Chart Time Frame You Should Consider?
Now, when you know that determining the market type is important, you may be confused about the time frame you should look at.
All time-frames have all market types and it’s only your preference to look at which one.
However, you must understand that with lower time-frames, you need to adjust to changes quite smartly. You will frequently see fake-outs so you have to be careful. On the contrary, higher time-frames give you much time to adjust to the changing conditions so you can trade more efficiently.
People generally adopt a strategy where they move from higher time-frame to lower frames. For example, first, they identify the market charts on the weekly time-frame and then shift to hourly or daily charts.
Along with knowing all about identifying market types and time-frames, you must also know how to limit your risks in each market type. When you know the market transition, you can very well adjust your stop loss. If you have a good exit strategy according to the market type, you can keep hold of your profits in a better way.
Forex Systems For Different Market Types
As mentioned earlier that it is not possible to have one system for all market types, you need to design or build a separate system depending on the market types and switch to a different one as the market type changes.
Here are some rough ideas of different strategies that work for each market type.
Buy and hold for Bull Normal
When the forex market is a bull normal type, you can buy and hold your trades with a trailing stop-loss. Until and unless, the market type is changing, you can stick to this strategy for gaining profits. If you notice any changes towards the volatile market type, it indicates that the bull market is going to end and you must tighten your stop now.
Long Swing trading for Bull Volatile
When the forex market is Bull Volatile, it’s time to trade actively. In this, the order of the day is profit targets. Find a profit-taking objective towards the long side after a pullback and a reversal. If you want to improve the risk/reward on the entry, you must drop to a lower time frame.
Sell and hold in Bear Normal
As opposed to the Bull normal market, you should sell short and hold the trade pairs with a trailing stop so that you can capture the majority of the move.
Short Swing Trading in Bear Volatile
In the forex market, the bear volatile market is opposite to that of the bull Volatile market. However, this is not true for trading stocks. So, take a short swing trading approach aiming at a profit target that delivers a good risk to reward ratio on your trade.
Breakout in Sideways Quiet
You can trade sideways quiet market in two ways.
Firstly, you can move to a lower time frame and then use a band trading strategy. If the currency pairs stay in this market type for some time, this strategy is very successful. With this, you can pick a lot of 2:1 and 3:1 risk-reward trade.
The other strategy depends on the result of this market. It is generally noticed that sideways quiet markets led to strong breakouts and trends. So, instead of trading in sideways quiet, you can shift to a new market type by trading breakouts. However, this is not a feasible option for all. This is because you have to bear several fake-out and false breakouts. And not all traders can handle this. For gaining profits out of them, you must have that psychology. However, if you execute a breakout strategy efficiently, this can prove to be a wonderful strategy over time.
Band Trading in Sideways Volatile
You can target a sideways volatile market with a band trading approach. You can get great opportunities for range trading in sideways volatile. However, you need to wait to move the edge of the range, move out of the Bollinger band, and then wait for the price to come back into the band for trading.
How To Deal With Your Strategy?
As we discussed earlier that you need to identify the market type and accordingly apply a strategy to maximise profits in forex trading. However, you can go another way also. For example, you have a strategy and that is working fine. So, instead of giving up on that strategy, you must find a market type where that strategy can perform well. In forex trading, you have to work on the system and the market type simultaneously. Prepare a toolkit of all the strategies that work in different conditions. Pull one strategy as and when an appropriate market type, suitable for that strategy, arises.
Start with identifying the different market types and accordingly figure out the strategy that works best in different market conditions. The main aim is to find out what works well and when.