Have you made money in some months, only to lose them all later?
Or…
You find a new trading strategy that makes money at the start, but stops working after a while?
What’sgoing on?
The reason is simple.
The markets are always changing.
It’s never fixed, but always in transition from one phaseto another.
This means…
If you’re using a trend trading strategy, then you’ll lose money in range markets.
And… if you’re using a range tradingstrategy, then you’ll lose money in trending markets.
So, in this postyou’ll learn:
- Stage 1: Accumulation phase where trend traders get killed
- Stage 2: Advancing phase which trend traders love — Best trading strategy is to long the uptrend
- Stage 3: Distribution phase where trend traders get killed, again
- Stage 4: Declining phase where traders turn into investors — Best trading strategy is to short the downtrend
You’d want to read every word of it.
The profitability of trading systems seems to move in cycles. Periods during which trend following systems are highly successful will lead to their increased popularity.
As the number of system users increases, and the market shift from trending to directionless price action, these systems become unprofitable, and under capitalized and inexperienced traders will get shaken out.
Longevity is the key to success. – Ed Seykota
The 4 Stages of the Market Every Serious Trader Must Know
Stage 1: Accumulation phasewhere trend tradersget killed
Accumulation usually occurs after a fall in prices and looks likea consolidation period.
Characteristics of accumulation phase:
- It usually occurs when prices have fallen over the last 6 months or more
- It can last anywhere from months to even years
- It looks like a long period of consolidation during a downtrend
- Price iscontained within a range asbulls & bears are in equilibrium
- The ratioof up days to down days are pretty much equal
- The 200-day moving average tends to flatten out after a price decline
- Price tends to whip back and forth around the 200-day moving average
- Volatility tends to be lowdue to the lack of interest
It looks something like this:
Which is the best trading strategy to use?
A goodapproachto trade in an accumulation phase is to trade the range itself.
This means going long at the lows of the range, and shorting at the highs of the range. Your stop loss should beplaced beyond the end of the range.
Here’s what I mean…
But:
In an accumulation phase, I would be more inclined to go short than long.Why?
Because you never know when it’s anaccumulation phase until the fact is over. I’ll explainmore on this later…
Nonetheless, I’ll trade along the path of least resistance, which is towards the downside.
Disclaimer: Please do your owndue diligence before risking yourmoney. I’ll not be responsible for your wins or losses.
Here’s an example of a trading strategy you can consider…
If 200 EMA is flattening out and the price has fallenover the last 6 months, then identify the highs/lows of the consolidation.
If price reaches the highof the range, then wait for price rejection before going short(could be in the form of Pinbar or Engulfing patterns).
If price shows rejection, then enter your trade at the next open.
If entered, then place your stop loss at the highof the candle, and take profits at the nearest swing low.
Which trading strategy to avoid?
Do not trade in the middle of the range as it has a poor trade location. Price could easily swing back towards the highs/lows.
This wouldresult in you getting stoppedout of your trades at area. It looks something like this…
I know you’re probably wondering:
How do Iknow if it’s an accumulation and not just another consolidation withina trend?
Something like this…The thing is…
You don’t know until the fact is over.
Because even the best-looking accumulation in the markets could turn out to be a consolidation within a trend.
Until the fact is over, I’ll trade along the path of least resistance, which is towards the downside.
Stage 2: Advancing phasewhich trend traders love — Best trading strategy isto long the uptrend
After price breaks out of the accumulation phase, it goes into an advancing phase (an uptrend) and consists of higher highs and lows.
Characteristics of advancing phase:
- It usually occurs after price breaks out of accumulation phase
- It can last anywhere from months to even years
- Price formsa series of higher highs and higher lows
- Price is trading higher over time
- There are more up days than down days
- Short term moving averages are above long-term moving averages (e.g. 50 above 200-day ma)
- The 200-day moving average is pointing higher
- Price is abovethe 200-day moving average
- Volatility tends to be highat the late stage of advancing phase due to stronginterest
It looks something like this…
Which is the best trading strategy to use?
In an advancing phase, you want to employ a trend trading strategy to capture trends in the market.
There are twoways to doit:
1) Trade the pullback
You can look to long when price pullback to key areas like:
- Moving average
- Support area
- Previous resistance turned support
- Fibonacci levels
An example…
2) Trade the breakout
You can look to long whenprice:
- Breaks above swing high
- Closes above swing high
An example…
If you’re interested, you can read more on how to successfully trade pullbacks and breakouts here.
When I am buying, I must buy on a rising scale. I don’t buystocks on a scale down, I buy on a scale up. – Jesse Livermore
Which trading strategy to avoid?
When the price is in an uptrend, the last thing you want to do is to go short, aka counter-trend.
I’m not saying it’s wrong, but the path of least resistance is clearly to the upside.
By trading with the trend, you’ll get a bigger bang for your buck as the impulse move is stronger than the corrective move.
Here’s what I mean:
Stage 3:Distribution phase where trend traders get killed, again
Distributionusually occurs after a risein prices and looks likea consolidation period.
Characteristics of distributionphase:
- It usually occurs when prices have risenover the last 6 months or more
- It can last anywhere from months to even years
- It looks like a long period of consolidation during an uptrend
- Price iscontained within a range asbulls & bears are in equilibrium
- The ratioof up days to down days are pretty much equal
- The 200-day moving average tends to flatten out after a price decline
- Price tends to whip back and forth around the 200-day moving average
- Volatility tends to behigh because it has captured the attention of most traders
It looks something like this:
Which is the best trading strategy to use?
A goodapproachto trade in adistributionphase is to trade the range itself.
This means going long at the lows of the range, and shorting at the highs of the range. Your stop loss should beplaced beyond the end of the range.
Here’s what I mean…
However:
In adistributionphase, I would be more inclined to go longthan short.Why?
Because you never know when it’s adistributionphase until the fact is over. I’ll explainmore on this later…
Nonetheless, I’ll trade along the path of least resistance, which is towards the upside.
Disclaimer: Please do your owndue diligence before risking yourmoney. I’ll not be responsible for your wins or losses.
Here’s an example of a trading strategy you can consider…
If 200 EMA is flattening out and the price has rallied over the last 6 months, then identify the highs/lows of the consolidation.
If price reaches the low of the range, then wait for price rejection before going long (could be in the form of Pinbar or Engulfing patterns).
If price shows rejection, then enter your trade at the next open.
If entered, then place your stop loss at the low of the candle, and take profits at the nearest swing high.
Which trading strategy to avoid?
Do not trade in the middle of therangeas it has a poor trade location. Price could easily swing back towards the highs/lows.
This wouldresult in you getting stoppedout of your trades at support & resistance area. It looks something like this…
I know you’re probably wondering:
How do Iknow if it’s adistribution and not just another consolidation withina trend?
Something like this…
The thing is…
You don’t know.
Because even the best looking distribution in the markets could turn out to be a consolidation within a trend.
This is why you always trade with a stop loss and proper risk management until the fact is over.
Trade along the path of least resistance, which is towards the upside.
Stage 4: Declining phase where traders turn into investors— Best trading strategy is toshort thedowntrend
After price breaks downof the distributionphase, it goes into a declining phase (a downtrend) and consists of lowerhighs and lows.
This is the stage where traders who do not cut their loss become long-term investors.
Characteristics of decliningphase:
- It usually occurs afterprice breaks out of distribution phase
- It can last anywhere from months to even years
- Price formsa series of lowerhighs and lower lows
- Price is trading lowerover time
- There are more downdays than up days
- Short term moving averages are belowlong-term moving averages (e.g. 50 below200-day ma)
- The 200-day moving average is pointing lower
- Price is belowthe 200-day moving average
- Volatility tends to be high due to panic and fear in the markets
It looks something like this…
Which is the best strategy to use?
In adecliningphase, you want to employ a trend trading strategy to capture trends in the market.
There are twoways to doit:
1) Trade the pullback
You can look to long when price pullback to key areas like:
- Moving average
- Support area
- Previous resistance turned support
- Fibonacci levels
An example…
2) Trade the breakout
You can look to short whenprice:
- Breaks below the swinglow
- Closes belowthe swinglow
An example…
If you’re interested, you can read more on how to successfully trade pullbacks and breakouts here.
Which trading strategy to avoid?
When the price is in a downtrend, the last thing you want to do is to go long, aka counter-trend.
I’m not saying it’s wrong, but the path of least resistance is clearly to the downside.
By trading with the trend, you’ll get a bigger bang for your buck as the impulse move is stronger than the corrective move.
Here’s what I mean:
For further reading, I recommend the works of Richard Wyckoff,Stan Weinstein, and Mark Minervini.
Summary of what you’ve learned
Click here to save this infographic.
#1: How can I know the difference between a “distribution phase” and a consolidation within a trend?
The truth is you’ll never know for sure. That’s why you must always have a stop loss and manage your risk properly.
#2: What’s the difference between a “accumulation phase” versus a “distribution phase”?
An accumulation phase usually occurs when prices have fallen over the last 6 months or more.
But a distribution phase usually occurs when prices have risen over the last 6 months or more.
Conclusion
You’ve learned thebest trading strategy for different market conditions.
In accumulation or distribution, you’d want to trade the range, and avoid a trend trading strategy.
In advancing or declining phase, you’d want to adopt a trend trading strategy, and avoid taking counter trend setups.
So, what is your best trading strategyfordifferent market conditions?
