Over the past few months Australian traders and investors have witnessed a divergence between the All Ords and the Dow Jones Index. Whilst this ‘de-coupling’ has been going on for some time with the USA indices rising by more than the ALL-ORDS, only recently has it had a negative impact on Australian sharemarket investors. The All Ords has experienced a 7% fall compared to a 2.5% decline in the Dow Jones. The USA indices have continued to rise while the All Ords traded sideways in a range. The fact that the overall market in Australia and a large number of shares have become stuck in a trading range has led to a period of frustration for medium term traders.
The chart below clearly shows the USA markets outperformance since the market bottom in March 2009 (Base Ref of the S&P500 from 6 March 2009) and the range bound All Ords that started in September 2009.
Medium term traders seem to be the worst hit during wide range bound markets. Short term traders, who are in and out of the market in either direction can do well in these market conditions if they have a sound strategy devised for range bound markets and a have disciplined approach to their entry and exit criteria and their money management rules. Whilst it is hard and time consuming work, short term traders are able to jump in and out of the market and take profits in either direction as the market oscillates within a trading range. This is one time when short term traders come into their own, and can actually enjoy these range trading markets if they have a range bound strategy and trading plan. Long term investors are also able to hang in there and weather the storm as their wider stop losses will hold them in positions longer. They will generally ride out these sideways market conditions with a breakeven outcome and only be forced to close positions (if they have an exit strategy) if the market is subject to a barrage of selling and prices tumble as they did during the GFC.
Range trading markets occur when prices trade in a range between a high and a low that they are unable to break through or penetrate for quite some time. Prices will bounce off the low of the range (or close to it) and look like they are about to start trending up again, only to run into resistance at the high of the price range (or close to it), and then fall back down to around the range low again. This can happen several times and over a period of several months until prices do finally break-out of the range to the upside (or downside) and once again a decent trend gets underway. In the meantime, a lot of false starts or false breakouts can occur as prices try to breakout through the resistance high, but quickly fall back into the range again. Depending on the width of the range bound market this can lead to periods of frustration for medium term traders reliant on medium term trends to generate profits from the markets.
As technical traders, we trade by the rules of the system we are currently employing and shouldn’t enter into the conjecture and opinion as to why the markets are behaving as they are. We either accept that they just are as they are and deal with what the market delivers or we make some adjustments to our trading plan either with the trading system or risk & money management, or both. Neither of these responses is right or wrong. What we cannot do is give up or freeze into inaction. As frustrating as it can be during these times we must stick to the rules of our current system knowing, by believing in its probabilities over a large sample and track record over the long term, that it will come out of a period of drawdown and once again get in sync with the market at some point when it will then be able to profit handsomely.
If we decide to make adjustments to our trading plan to cater for range bound markets then clear-cut objectives must be set as to why. New concepts should be identified and researched ensuring that any adjustments do not negatively affect the system in periods outside of range bound markets such as upward and downward and narrow range bound markets. While we are doing research we should continue to trade what is known, which is our current system, until we complete our research.
It is during tough market periods that all we have learnt about discipline, consistency, objectivity and thinking in terms of the market paradigm needs to be applied but also gets tested. It is in essence, where the ‘rubber hits the road’ as all the reading, studying and research we have done MUST now be applied in real time to the disciplined application of our trading rules during a very frustrating and difficult time in the markets. It is a true test of our new found skills as objective, professional traders and active investors as we journey on this never ending path of growing and improving.