Market Environment Types Explained
Knowing the types of market environments is not rocket science but identifying the environment in real-time can be difficult. If you want to know the types of market environments and how to access the conditions, then read on
What will be discussed?
- What are the types of market environments?
- Chart examples with explanations.
- Why do these environments occur?
- How to determine the current market environment in real-time?
- How to access possible shifts in market environments?
- Affect of conditions on strategy performance.
Types of market environments
There are only 2 main types of market environments, trending markets and ranging markets. Generally, the market is in a range 70% of the time and trend 30% of the time.
A range means that price is trading between certain prices for an extended period without exceeding the support and resistance levels. So in a range bound market prices trade within a price area/ band.
Trending environments occur when a market moves in a definitive direction i.e. the market is increasing or decreasing in value. In up-trending markets prices make higher lows and higher highs while in down-trending markets prices make lower highs and lower lows.
It’s pointless for me to continue writing without slapping some charts down showing what these environments look like.
Range example- EURGBP H4
The market is confined between the support level and resistance level, therefore the market is ranging.
Uptrend example- GBPUSD Daily
Series of higher highs and higher lows indicate that the market is trending up.
Downtrend example- NZDUSD
Series of lower lows and lower highs indicates that the market is trending down.
Market environments on different timeframes- AUDJPY
The market can be in different environments depending on the timeframe that is being analyzed. As shown in AUDJPY the market is in a downtrend on the Daily due to a series of lower lows and lower highs. However, the grey area highlighted indicates a range on the lower timeframes.
Why do these market environments occur?
Why do range environments occur?
Supply and demand dictate moves in the Forex market. Ranges occur because supply and demand is relatively balanced i.e. neither bulls or bears are strong enough to overpower the other side and create a directional trend. During ranges, volatility and volume are usually low.
Why do trending environments occur?
When there is an imbalance of supply and demand this will lead to a trend occurring. More demand equals an uptrend and greater supply equals a downtrend. The market will continue to trend until forces balance out once again and a range will result. During trends, volatility and volume are usually high.
How to determine the market environment in real-time?
The best way to determine the current environment is to use our definition from earlier. Should the market be making continuous swing highs or continuous swing lows then the market is trending. However, if the market is stuck between levels of support and resistance then the market is ranging. All traders wish it was this simple though, the market could also be in between two phases. But its ok, don’t worry, next up is how to determine shifts in the market environment.
How to determine shifts in the market environment?
All markets shift between trending and range bound, so it might be easy to identify the environment itself but its far more difficult to tell when it might change. Trending environments are associated with higher volatility and volume; range environments associated with lower volatility and volume. Therefore traders can use this to determine when a shift from a range to a trend might occur and visa versa.
Should the market be in a range and price is moving close to resistance on high volume as well as quickly (volatility), this is a sign that the market may breakout of the range and trend. Traders should prepare for this possibility of they see these signs.
Conversely, if we are in a downtrend and the market has been struggling to make a new low and volume has been decreasing, this could mean that the bears have run out of steam and a range could be on the horizon.
Although it is impossible to predict with certainty, by using volatility and volume traders can prepare for a shift in market conditions.
Affect of conditions on strategy performance
You might be wondering after all that reading, why is it important to know the different market conditions and how to identify the shifts between them? The reason is that conditions affect the performance of all strategies, so it is important to know how your strategy performs/ acts in different environments so that you can make the best decisions for your trading results.
Know the market and it will be a great friend to you