Adapting to Trending or Choppy Conditions While Day Trading EURUSD
The daily movement of the EURUSD can be categorized in two ways: trending or choppy. Forex day traders will face both environments during a trading week, and potentially even within the same day. The trick is being able to adapt, because trying to trade trends in choppy market conditions will lead to poor performance. By understanding price action we can adapt to either environment. Here’s how.
EURUSD Trending and Choppy Environments
A trending environment is when price tends to make multiple wave movements in one direction. The price may reverse, but then makes multiple wave movements in the other direction. Trending days are typically easiest to trade. For example, the price may move up, have a retracement/pullback, then move up again. We are now interested in taking a long position on the next pullback. As long as the 2-steps-up-1-step-back pattern continues we potentially make money.
Source: My Forex Broker FXOpen
Buying during pullbacks in an uptrend–as discussed in a number of strategies in my Forex Strategies Guide eBook–will likely produce more winners than losers and an overall profit at the end of the day, even if we do take a few losing trades, because the trends have multiple waves in the same direction.
Choppy conditions are tougher. The price may make a big move up, and an even bigger move down, then a little wave down, then a big wave up. It is not orderly like a trend is. If the price moves up and then we try to buy on a pullback, in choppy trading the price isn’t as likely to move up again. The price movement is more random.
During choppy trading, most traders are better off staying away, and not trading. Step back in only when trends form. This may occasionally mean making no trades at all during the hours that you day trade. Day trading is only recommended during the London session or London/US period. Other times are typically not ideal for day trading, as discussed in the section below.
An uptrend is defined by overall high lows and higher highs on the price swings that form the trend, and a downtrend is formed by lower highs and lows. Choppy trading is when this pattern keeps getting broken. You may have a higher high and higher low, followed by a lower low, then a higher high, then a lower high, and so on. Essentially, the market is showing us that we can’t assume the price will continue to move in one direction for any length of time. And the random dispersion of swing highs and lows also makes it hard to estimate when a reversal may come. Choppy trading isn’t always confined to range like it is in the chart below. Sometimes the choppy price does make progress in one direction or the other, it just does so without following the pattern of a typical trend (higher highs and lows, or lower highs and lows).
How can you tell when you are entering a choppy period? If two trends in a row start, but then fail. Just prior to vertical line there is a move up composed of wave up, pullback, wave up (this is when we can assume we have entered an uptrend), pullback, and then price fails to make a higher high and follows it with a lower low. That is a failed trend. The same thing happens on the downside just to the right of the vertical line. The price makes a wave down, a pullback higher, then another move down. These are signs of a downtrend, but then the price proceeds to make a higher high. Another failed trend. That indicates a choppiness. Until we see a trend that sustains itself for multiple moves, it is probably best to stay away.
Time of Day Tendencies For Trends and Ranges
As a general guideline, if the price is moving less than about 25 pips in one direction before reversing significantly, that is a sign of choppy trading. Trends tend to produce long moves which in turn produce a larger daily range (the difference between the highest high of the day and the lowest low).
The London session, before the US open, tends to be fairly trendy. Once the US opens, the EURUSD may be trendy or choppy, but the amount of movement typically picks up. If the amount of movement does not pick up once the US opens, that is a sign that the price action will likely be choppy until proven otherwise. Once London closes, and only the US is open, there is often less movement and the price action becomes choppy again.
Between looking at wave/swing highs and lows, and these other tendencies discussed above, we can (with practice) discern when to trade and when not to quite quickly as market conditions change. We likely only need to have one or two losses before we see that conditions are not ideal for our trending day trading strategies. Such losses are recouped once the trending movement begins again, considering profitable trades are bigger than losing trades. This is discussed in the next section.
Examples of Adapting as Trading Conditions Change
The 1-minute chart below is from the London session. There’s an initial rally, so the default response it to look for trade setups that will get us into a long trade. When I see a trend, I trust it until there is evidence to the contrary. [For an uptrend, evidence to the contrary would be a lower swing low, a lower swing high, or an upward move that barely makes it past the prior high, an upward move that lacks velocity relative to any recent down moves, or a downward move that is so strong that it will likely create a lower swing low even if it hasn’t quite yet.]
The preferred method is to wait for pullbacks that then consolidate (or an engulfing pattern during a pullback). Waves are measured once the day gets underway, for determining target placement. In strong trending markets, targets can typically be placed at a 2:1 reward:risk ratio, or even a bit more. By entering when the price moves above a consolidation (uptrend) and placing a stop loss one pip below the consolidation low, you will also know what your risk is before each trade. Most days it will be between 4 and 7 pips, depending on volatility. While 2:1 reward:risk is nice, under most day trading conditions a 1.6:1 ratio is recommended. This increases the chance of the target being hit, but still provides a well-sized profit relative to the risk. It also means our trades don’t take much time and we can start watching for the next one.
Within the first three hours of the London session, there were three trades. The first two trade setups that triggered reached the 1.6:1 target, and would have likely reached the 2:1 target as well (assuming no slippage on entry and a tight spread). The third trade didn’t reach the target, but could have been exited for a tiny profit (about 2 to 3 pips) when the price made a short-term lower low, breaking the small rising trendline.
First trade: risk 6.3 pips, target at 10.1 pips. Result +10.1 pips.
The next trade/box was valid but didn’t trigger because it didn’t rally above the consolidation.
Second trade: risk 6.8 pips, target at 10.9 pips. Result +10.9 pips.
The next trade setup was valid, but didn’t trigger.
Third trade: 4.8 pips risk, target 7.7 pips. Target not reached (came within about a pip). Exit when the price shows sign of a reversal. Result +2 pips.
Total pips: 23 pips. If risking 1% per trade, account equity increased by 3.61%.
The price continues to fall during the latter part of the London session. The decline was quite swift, so there weren’t a lot of opportunities to get in on a pullback. There was an optional trade on the decline. The price drops, followed by the consolidation, then the breakout to the downside. [By ‘optional’ I mean you really had to be on your toes to catch it because the default response it to want to wait for a deeper pullback. But in strong trends that doesn’t always happen…like in this example, or on the first trade of the day.]
As we approach the overlap period (green), the price is already showing signs of choppiness. There is no follow through in the trending direction following pullbacks. Instead, small ranges develop and the waves are getting smaller. The smaller the price waves, the harder it is to make a profit, because there is less movement (profit potential) and the spread becomes more of a factor. Through the first 1:45 of the overlap period there wasn’t a valid trade, in my opinion. That said, since the method is subjective traders may have found a few entry points, but would have likely had to bail early on their trades taking small profits or losses. Conditions just weren’t right for big profits.
This is probably one of the hardest things in trading…to not trade when conditions aren’t ideal. In Trading Tips From Millionaire Trader, the topic of risk management is discussed; one of the best risk management techniques is to not get involved when conditions are unfavorable. Just because you want to day trade today, at this moment, doesn’t mean a valid opportunity will present itself.
Sure, maybe it was possible to make a bit of money in the overlap (green) period on the chart. But it would have been a lot tougher than earlier in this particular day. Notice the different structure of the London session compared to the late-London and overlap period. If you’re a trend trader, you thrive in the former environment and have to be able to step aside during the latter choppy environment. Ask yourself constantly throughout the day if your target is likely to be reached based on the market movement.
Also, consider how much “margin of error” there is. For example, if your target is 10 pips and the price is typically running 15 pips one each wave, you have a nice margin for error there. The next wave is likely to move far enough to reach your target. But if price is only running 10 pips typically, and your target is at 10 pips, you have very little margin for error. Accounting for the spread and possibly a bit of slippage on the entry, you have a low probability trade. I call this type of thinking, “trading beyond the hard right edge.” You can read more about it in How to Day Trade Forex in 2 Hour or Less.
Typically the overlap period is a great time to trade, but occasionally it is not. The London session is also usually great for day trading, but not every day. Be willing to walk away when conditions aren’t favorable, so you have money and confidence to trade when conditions are ripe.
By Cory Mitchell, CMT