Successful trend trading takes a combination of faith, iron discipline and a solid position size strategy to stay the course to avoid risk of ruin. This faith can be tested many times because the markets only trend around 15% to 20% of the time. This can cause stress and sleepless nights while waiting for the markets’ next big opportunity.
But, there is potentially a greater opportunity for a trade in the 80% to 85% of the time when the market is trading sideways.
A reliable trading method attempts to adapt to the environment and attack from the most advantageous position. For trading, you have to know the current market conditions in place since that will dictate the most advantageous position to profit from. There are three market conditions in play at any given time: bullish, bearish and range bound.
Because the markets only trend a small portion of the time, the majority of the time it is trading sideways (or in a range). This phenomenon occurs because neither bulls nor bears have seized control of the market to force it into a trend, so it remains in a trading range. Trading ranges form between two price levels — support and resistance — which trade back and forth. Smart and quick traders can profit in range-bound markets by buying tests of support and selling tests of resistance, but there are dangers from support and resistance trading that experienced professionals know that a novice needs to learn before jumping in.
The first of which is that there are no sure things in the market, even with something as clear-cut as support and resistance trading.
Seminar promoters and market technicians paint a rosy picture of trading off these price levels to set off on the road to profitability. But, if you’ve ever actually attempted to do it, then you realize it’s not that black-and-white.
Price can trade below a support level and keep trading lower just long enough to hit everyone’s stop loss orders before trending back higher.
Resistance levels may seem solid, but the market has an overall bullish bias, which can make shorting the market dangerous for individual traders.
Price action in a sideways market can resemble the erratic motion of the sidewinder snake, which travels in an irregular sideways motion as it makes its way through the desert terrain. This makes price travel in a hypnotic pattern but hard to pinpoint where one price movement ends and another begins.
This is because market volatility can ebb and flow at any given time and make static price levels unreliable. Support and resistance should then be considered a guideline, not the rule.
Once you begin to understand that part of the equation, it’s a matter of finding the rest of the formula to succeed.
Finding Your Niche
Traders of all experience levels actively seek any edge that will take their performance to a higher level. Looking to a heavily marketed mechanical trading system, buying the newly released trading guide by a famous personality, or trying to match the trades of your favorite hedge fund manager, misses the point entirely.
All of these things have their place but the biggest edge that you can have is to find a trading method that matches your personality. There is a reason that a Warren Buffett or Paul Tudor Jones can sit back calmly and make trade decisions that would crush normal traders. They both found a method that suits their personal set of beliefs about the market and matches their own unique personality.
If you lack either of those traits then the odds of you being able to maintain discipline is going to be slim to none. Discipline is the glue that holds together the foundation of your trading approach.
To maintain trade discipline in trading support and resistance levels you need to be more comfortable with short- to intermediate-term time frames. You also have to be comfortable with putting no more than 2% of your capital at risk. Finally, you need to have the ability to act at the right time when putting a position in play and taking profits at the price target.
If those are guidelines that are in-line with your personality and don’t conflict with any belief you have about trading the markets, then you already have an edge in using this trading style.
Now, you just need a reliable rules-based approach.
Know Market Conditions
It is important to define when a market enters a sideways period. On March 27, the Dow Jones Index set a low at 20,412 that was later tested on April 17. This support level was confirmed at the same time price traded beyond the lower Bollinger Band creating the condition for the sidewinder setup (see “The set-up,” right). The following day, price closed above the high of the previous bar signaling an entry. During the next three days, price traded up to and beyond the upper Bollinger Band for a potential gain of 331 points.
When Netflix (NFLX) tested support at $139 and dropped below the lower Bollinger Band on March 3, the Sidewinder Method was queued up and was triggered the following day for an entry of $141.94 (see “Sidewinder launch,” below).
The Sidewinder Trading Method
You now understand that trading between price levels isn’t a sure thing and that there takes a certain amount of finesse as well as the right temperament.
But, if you have those pieces of the puzzle then the remaining pieces are in the form of a reliable rules-based approach that gives you an edge.
The trading approach has to take into account certain technical considerations like identifying support and resistance levels but also volatility and how it reacts when trading at extremes.
The Sidewinder Trading Method combines the best elements of trading in a price range while integrating certain realities of market volatility. This combination is designed to increase the odds in your favor by giving you a distinct edge in a sideways market.
The Setup Rules:
1. Use daily price data
2. Overlay Bollinger Bands on the daily price chart
3. The underlying security must be trading sideways between support and resistance levels
4. For long entries, wait for the stock to trade below support while trading beyond the edge of the lower Bollinger Band
5. The setup occurs when a price bar establishes a significant low
6. The entry is triggered when a following price bar closes above the high of the price bar that established the significant price low
When price is trading in a range its volatility begins to contract, but when it trades beyond its established price levels then volatility expands. Bollinger Bands are designed to give you a visual reference on an underlying security’s volatility. When price trades beyond the limits of the Bollinger Bands then the underlying security is trading at extremes.
But, at some point, volatility reverts to its mean, which is basically like saying, “What goes up must come down, and vice versa.” It’s like a rubber band that gets stretched too far but then snaps back into place.
So, when price trades through its established support/resistance levels while also trading beyond the limits of the Bollinger Bands, it creates an opportunity for you. You gain an edge by waiting for price to revert back to its mean like the rubber band snapping back after being stretched too far.
“Riding the wave,” (below) shows that seven days after the initial setup, NFLX reached the upper Bollinger Band signaling an exit. After trading in a range, on April 19, NFLX retested support and breached the Bollinger Band creating another setup. However, the following day NFLX failed to close above the setup day high.
Instead, an inside bar formed, which could or could not have been traded depending on the skill of the trader. If you followed the rules then you would pass but lose out on a potential 11-point gain. Unfortunately, this happens in trading and you have to be mentally prepared to move on to the next trade without dwelling over missed opportunities and focus on the long-term.
Use Caution Shorting
You can follow the same guidelines for shorting an underlying security by reversing the last three rules, but you should be cautious. While reversing the method works well with futures or forex trades, there are rules in place to discourage shorting stocks in the market like the “uptick” rule. You literally have to wait for price to go up before you can gain an entry and ride the stock down.
This dulls some of the edge you gain with this method because there is a chance that price could continue to go up without ever going down. Again, this fact takes away part of the edge you gain. You could use options with this method but you need to be mindful that volatility expansions can temporarily increase an option’s price.
Refining Your Edge
With the market trading sideways the majority of the time you’re going to find a lot of trade candidates with this method.
That said, you can refine it further by sticking with stocks or securities that trade above the 200-day simple moving average. The moving average acts as a trade filter to help you identify long entries that have a stronger bias to snapback to the upside.
Profit targets are typically the upper Bollinger Band, but you can take partial profits on large moves at the median line and the rest at the upper band if you want to reduce the chance of losing all of your profits and getting stopped out when a rally fades sort of your target.
Whichever profit taking strategy you take, just be sure to limit your risk to no more than 2% of your trade capital. In using the Sidewinder Trading Method, you will trade more often and see a high probability of winning trades and you won’t overexpose yourself to risk of ruin. It’s a good way to trade markets that are not trending, which occurs more often than not.