The different ways markets react in a sideways versus trend environment can be dramatic and should affect how you enter trades and how you react to technical signals. So how can you identify conditions when you need to be more or less aggressive on your entry and risk management?
In a sideways market the most profitable technical tools to use are the Relative Strength Index (RSI) and stochastics. We will fade the trend when these indicators reach extremes. If the trade is dead wrong we get out at a predetermined risk, if the trade is marginally negative we get out by the third day. In a trending environment we will use the RSI and stochastics in a completely different way. As long as our trend indicators are strong, we will use the RSI and stochastics as a measure of retracement. When these indicators are no longer overextended, then we will enter with the trend and trail the trade with a stop.
We realize that technical traders avoid fundamentals, but knowing some fundamentals of the market help our traders to identify market conditions to apply a sideways or trend based trading approach. As for volatility, we have found that charting the fund positions help in identifying which conditions to implement a more or less aggressive trading approach.
Currently grain markets provide a good example. The world's ending stocks (the inventory left over at the end of the year that can be used in the following year) of starched grains are at the lowest levels since world data has been recorded. The combined end stocks of rice, wheat, barley, sorghum, rye and corn has fallen to less than two bushels per person in the world. That is alarming for any major processor of food, livestock feeder, ethanol processor or foreign government official needing to assure his country of an adequate supply. Simply put, if there is a production problem, there are not enough supplies of substitutable grains to go around.
Because of this, the starched grain markets should have a much faster or volatile jump when any buyer, speculative or commercial, steps in; it is a sellers market. This should create great trends. Additionally, the commitment of traders report indicates funds have lightened up on their long positions and are now ready to refuel another strong leg up. Wheat, rice, corn and even barley all have positive Moving Average Convergence Divergence and momentum is strong. As soon as RSI and or stochastics pull back from overbought to neutral, it will be a good time to get long.
Bill Biedermann has been in the futures business for 27 years and is senior VP at Allendale Inc., which provides research, consulting and brokerage services for cash related clients, speculators and commodity funds.
