From the May 2013 issue of Futures Magazine • Subscribe!

Volatility-based support trading

For more than 14 years, traders have been whipsawed back and forth by the stock market with little to show for it — except for mounting frustration and declining trading capital. Until recently, since the dot-com era went bust in March 1999, the market has traded with all the zest and enthusiasm of a lead balloon. It has made anemic attempts at bull runs only to roll over into steep price declines before re-starting this up-and-down pattern over and over again.

Sometimes for extended periods, price breakouts will fail with few real trends developing into any meaningful move as the market continues to trade sideways. Trading support and resistance levels would seem logical, even easy, to do in the current market environment, but as with most things in trading, this is easier talked about than put into practice.

One reason for this is the frequent failure of traditional tools for sideways markets. While conventional technical analysis may give you a glimpse into the mechanics behind these moves, if you can see them, then other traders can see them as well.

Human behavior & volatility

There are three market types: Up, down and sideways. Simply knowing you are in the midst of an extended sideways trading period doesn’t make the market easy to trade. In much the same way that market conditions have changed for trend trading and breakout trading, sideways markets have evolved and new methods have been needed to trade them effectively.

The goal is to develop a method that pinpoints optimal price levels for resistance and support, minus the unpredictability. To accomplish this, we need an approach that doesn’t rely on static points in an underlying security’s price action, but one that can reflect the dynamic and ever-changing state of the price action itself.

One reason for this might be that more traders identify the market as sideways. As a result, they have changed their trading approach to adapt, and static support and resistance price levels have become more volatile and less predictable. Static supports are relatively easy to identify by other traders and they become battlegrounds for bulls and bears who are attempting to seize control of price movement. The result is that price action tends to behave erratically, causing stop loss points to get stopped out before trades have a chance to profit.

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