Tuesday, October 13, 2009

Thoughts on Trading Choppy Markets

I hear from many traders that it's impossible to ride a market move or trend due to the choppiness of markets. To be sure, we've seen a good amount of mean reversion in markets over the short run; as I pointed out a while ago, about 85% of trading days will take out their prior day's high or low, but only about half will sustain the strength or weakness. Closer to the market, it's not unusual to see buy and sell programs move the market sharply higher or lower, only to turn on a dime and retrace the moves.

The idea that choppiness is an impediment to trading trends, however, is not exactly true. Choppiness is an impediment to *momentum* trading: buying highs and selling lows in expectation that momentum will persist. One can do quite well riding a market move by using the countertrend chop as opportunity: buying weakness in a strong market and selling strength in a falling market.

The shorter the trader's time frame, the more execution accounts for a major portion of P/L. Two traders can have the same idea to go long stocks: one buys new highs, the other waits for a pullback and gets a better price. Over time, that execution edge adds up.

Choppiness need not be a threat: the key is to stand outside the chop at a larger time frame and figure out how movement against the bigger picture can pose opportunity, rather than threat.