Irrefutable Law of Trading Success #8: Trade with the Market Environment

This law is one of the most important laws, of course, they're all important, that's why they're laws. But this one in particular, it so often solves the issues with traders and their performance. And why is that? Well, traders learn a pattern or they learn a system and then they run it and they know it works. They believe it works and it works and it works and it works and it stops and it stops working and then I don't know why it stopped working. Well, usually what's happened, when it stops working is the environment that it was favorable for the system or favorable for the pattern has shifted or no longer in that environment. We could have a pattern, for example, that identifies oversold conditions and stocks and so when the stock gets oversold, we buy it.

Well, if we're in a bullish environment, that pattern will work really well and when the stock sells off, it'll reject and come right back. A pattern like that can work really well. But when we're in a bearish environment, what will happen is a stock will get oversold, and it won't bounce. It'll sit there or I may even go lower. But it will not show the reversion that it showed before. And why is that? Because the environment shifted. One really simple frame is to understand the market environment and then trade congruent with it. Many people love mean reversion trading, well mean reversion works great when you're in a congestion. It works great when the markets overbought or oversold. But if you're not in a congestion and you're not overbought or oversold, mean reversion doesn't work very well.

A lot of mean reversion traders have a high win rate, they'll win, they'll win, they'll win, they'll win and then wham, they get killed. And why is this Because they're selling essentially what ends up being a breakout or shift in the environment. For you, you want to understand what the market environment is, if the market is bullish, you want to trade long, if it's bearish, you want to trade short. If it's congestive, you want to trade around the range, you want to buy the bottom of the range sell the top of the range, keep this very simple, but this is a general idea. We also want to understand the volatility environments. Is the market quiet? Is the market normal? Is the market volatile? 

Okay, when we compare directional environments with volatility environments, we start to understand very well what kind of systems or what kind of patterns we should pursue for that environment. For example with us, we had a major shift. The market has just been going relentlessly higher since early November. November, December, January, February and even March, the market was going up five months. It was bullish and volatility in general was coming in so it was bullish to normal or bullish to quiet. Is a great environment to trade Longs. Well, last Friday, the environment shifted. One is know at the market environment is in this case bullish and then trade bullish strategies.

Number two, know where the market environment changes or where it shifts. And when this happens, this is where you need to take action. This is where you need to shift your strategy. This is where you need to get out of your positions. For us, we were long, but then on Friday, everything shifted. We were no longer in a bullish environment. We now are in an environment that is short term bearish. Long term is still bullish, but short term is bearish and so we're not going to be long. Or if we have some Longs, we're going to have them against shorts. Okay, so the environment shifted and what did we do? We got out and then look at today, markets down big today. This is what happens. Okay, so we understood the environment, and we understood where it shifted. A lot of people can understand what the environment is, they don't understand when it changes, that's the harder part. Or they know it's changing but they don't want to believe it because they know this is gonna mean they can't make money anymore. Okay, so then they fight it. 

One, how do you identify the current market environment? And two, how do you identify where it shifts? I want you think about it, if you know where it shifts, you can have plans in advance set up, such when it shifts you already know the action you're going to take you take that action, you're out, you're free, clear, ready to respond to the next environment. Great traders can trade any environment, not just the bullish environment, not just the bearish environment. There you have it, Law number 8: Trade with the market environment and know where it changes. Every Tuesday I come to you with a trader tip that helps you take your performance to an elite level. We did that today and I'll see you next Tuesday.