Bulletin # 28
June 29, 1999

Identifying Market Conditions

We have been having some very interesting discussions on our Forum. One of the threads that I have found to be particularly interesting recently is on the subject of
Curve Fitting/ Over-optimization at http://traderclub.com/cgi-bin/discus/show.cgi?18/45

I was about to post a response to one of the many excellent messages in this thread when I decided that this rather lengthy response might make an interesting Bulletin.

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Snip from message from Kevin Morgan on 6/27/99 - Kevin stated:

"My conclusion is simple. We need to focus on two things:

1. A typography of market conditions.
2. Effective trading methods for each. "

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An excellent post, Kevin. Thanks. I agree. Lets tackle first things first. Let’s try and work out a concise breakdown of market conditions and once we have done that we can try to find ways to identify and then trade each condition.

I would propose that market conditions can be defined using three elements: direction and slope are the two I am most positive about. The third possibility is either volatility or orderliness, or perhaps both. I would like to have some help on this from our members so feel free to jump in and agree or disagree and contribute any ideas. Consider my ideas as just a place to start.

Direction = up, down or sideways. I think it is important to think of sideways as a direction when describing market direction. Here is a sample of how this logic might appear:

Upward Direction
A. Upward with low slope (Direction is up but slope is low. The market is moving up gradually.)
B. Upward with high slope (Direction is up and slope is steep. The market is moving up rapidly.)

Now I believe that we might want to add another factor that would further define the conditions. That factor would relate to the size of the short-term deviations from the general slope.

Lets assume that we are moving upward so that a trend line under the lows points upward at about a twenty degree angle. If we now draw an approximately parallel line along the highs, the trendline along the highs could be close to the trendline of the lows or it could be far away. The space between the trendlines could be referred to as the amount of short-term volatility or disorderliness. If the lines are close together we will describe the slope as “orderly” and if the lines are far apart we will describe the slope as “disorderly”.

I doubt if I would actually want to use trendlines to measure or identify these conditions but it helps in visualizing what I want to describe. As you can easily tell, I’m not a mathematician. I’m simply trying to paint a verbal picture that we can use to describe various market conditions. Our outline of market conditions would now look like this:

Upward Direction
A. Upward with low slope (Direction is up and the market is moving gradually.)
1. Orderly (We will call this “Condition 1”. )
2. Disorderly (We will call this “Condition 2”)

B. Upward with high slope (Direction is up and the market is moving rapidly.)
1. Orderly (We will call this “Condition 3”)
2. Disorderly (We will call this “Condition 4”)

Sideways Direction (No slope to measure. Our trendlines are both moving sideways.)
A. Orderly (We will call this “Condition 5”)
B. Disorderly (We will call this “Condition 6”)

Downward Direction
A. Downward with low slope (Direction is down and the market is moving gradually.)
1. Orderly (We will call this “Condition 7”)
2. Disorderly (We will call this “Condition 8”)

B. Downward with high slope (Direction is down and the market is moving down rapidly.)
1. Orderly (We will call this “Condition 9”)
2. Disorderly (We will call this “Condition 10”)

There you have it. We have identified ten different market “conditions” that will have major impact on the results of various trading systems. (Actually I am going to add an eleventh condition called “Unknown” or “None of the above.”) Next we need to figure out how to identify each of these conditions systematically and incorporate that analysis into our trading systems. Send us your ideas and suggestions for code and indicators that would identify each condition. Here is a review of the eleven conditions:

Condition 1 = Market is moving upward gradually in a narrow channel.
Condition 2 = Market is moving upward gradually in a wide channel.
Condition 3 = Market is moving upward sharply in a narrow channel.
Condition 4 = Market is moving upward sharply in a wide channel.
Condition 5 = Market is moving sideways in a narrow channel.
Condition 6 = Market is moving sideways in a wide channel.
Condition 7 = Market is moving downward gradually in a narrow channel.
Condition 8 = Market is moving downward gradually in a wide channel.
Condition 9 = Market is moving downward sharply in a narrow channel.
Condition 10 = Market is moving downward sharply in a wide channel.
Condition 11 = Unknown or none of the above.

Come join us in our Forum discussions. We want to have the best discussions for traders on the web. We think we are getting there. http://www.traderclub.com/discus/board.html

Good Luck and Good Trading
Chuck
mailto:chuck@traderclub.com
http://traderclub.com