Most trading systems are affected by the overall market conditions of the markets
they trade. Robust systems will make money in nearly all types of market, but
will make more in some types of market than others. For example, most trend following
systems are especially vulnerable to many small losses when the markets they trade are moving sideways.
This eBook details a systematic way to classify the current market environment
based on trend and volatility, and gives a way to test the performance of your trading systems to see if they are vulnerable
to changes in market environment. This allows us to only trade a system when market conditions are favorable, and either reduce
or eliminate the capital allocation to a system when market conditions are unfavorable.
A particular market can be classified in 2 ways:
Volatility (Low, Normal, and High)
Trend (Up, Down, and Sideways)
These 2 classifications can be combined to give us 9 different possible types
- Low Volatility, Up Trend
- Low Volatility, Down Trend
- Low Volatility, Sideways Trend
- Normal Volatility, Up Trend
- Normal Volatility, Down Trend
- Normal Volatility, Sideways
- High Volatility, Up Trend
- High Volatility, Down Trend
- High Volatility, Sideways
Methods for classifying a market into Low, Normal,
and High Volatility, and Up, Down and Sideways Trend will now be discussed, as well as how the market type can be used to
manage your trading systems effectively.