Trade Trendless Stocks
How to Trade a Sideways Stock Market
When markets are moving sideways or in a trading range, moving average crossover systems and other trend-following systems are more often whipsawed. One day a stock will give a buy signal, and the next day it will give a sell signal. Professional traders will often abandon trend-following systems under those conditions. However, here are a couple of strategies that we have found to be quite effective, even when the market as a whole is not going anywhere..
Under these conditions, when we buy, we buy very strong stocks. We also try to buy on trigger events with good setups (see our videos for more on this). We also tend not to expect to be in a position for a long time. That does not mean we expect trends of our strongest stocks to be short-lived. It means we will buy with a goal of capturing most of the gain during the period of maximum price acceleration, and then lock in that gain at the first sign of weakness. After we sell, the stock may continue upward after a relatively small correction. Most of our selections will do just that. However, our tolerance for the downside is less when the market does not have positive momentum that can help individual stocks along. If under those conditions we have a good gain for the amount of time we have been invested, we find it easier to lock in gains rather than ride out small declines. We may also repurchase a stock we previously sold if the setup is right and the balance between risk and probable reward is attractive (assuming that we expect another period of price acceleration). Again, we look for setup situations because those are what enable us to be in a stock when it is on the move. We suggest that buyers have stop losses in place and adjust them upward as positions rise.
The key to this approach is finding strong stocks. By strong stocks, we do not mean stocks with a high RSI. The RSI typically measures only 14 days of price behavior. Even stocks with the greatest RSI can have a lousy chart pattern. For our own trading, we had to create an algorithm that locates stocks that have strong chart patterns. What we want are stocks that steadily climb without a lot of erratic price behavior. You could, for example draw a trendline at a 30- or 40-degree angle, and the stock would essentially travel along that line without inexplicably plunging below the line now and then. Even when the market is in a relatively narrow trading range, we often find plenty of stock’s like that.
The experience of our traders at stockdisciplines.com and the research of the author both confirm that such patterns are highly resistant to short-term market funks. Instead of breaking their rising pattern during the time when the market declines to the bottom of its trading range, such stocks often will do little more than decline to their rising trendline. This gives an excellent buying opportunity. However, we think it is wise to wait for a sign that the rising line of support is still intact. If the stock were to begin to rebound off that trendline, it would be evidence that the trendline is still providing support.
If we are using a trend-following moving average crossover system, we might require that the crossover be maintained for two consecutive days or more to be sure it is not just a whipsaw situation. Alternatively, we might require that the short-term average be at least a certain percentage above the long-term average before it is considered to be a crossover.
A final example of how to trade in a volatile market would be when a stock breaks out above a trading range. Instead of buying on the breakout, we would wait for a pullback to the breakout level. If the breakout level acts as support and causes the stock to resume its climb, then the stock might be purchased. However, if the stock falls below the breakout level, we would go elsewhere.