When you’re a trader, you’ll quickly have to deal with a “Choppy Market.” A choppy market is one without any clear direction and guess what? Eighty percent of the time, a market is choppy. These flat chart patterns can be seen in nearly all asset classes (stocks, futures, and even cryptos). By their nature, choppy markets aren’t easy to trade because there’s no indication of a direction the market will eventually head. Assuming there is a breakout, it can backfire. And the stock falls again.
How Do You Identify Choppy Markets?
When we have a choppy market, we want to know how to spot it. So you do that? By mapping out the high point and the low point of the current market. As a result, you’ll have a range you’re looking at. Then as price bounces around that range, you’re in a chop fest. You want the market to break out of that range of the high and low. Then you have a direction; whether bullish vs bearish.
Identifying and Quantifying
After a long bull or bear market, choppy markets can be present and are most prevalent outside of earnings reports and announcements. To identify a choppy market, you must first locate the top high and bottom low seen over many sessions.
These two points will define your range. You will then want to see how the asset acts in the range. If it pushes against any support/resistance and breaks through before losing volume and returning after nearing the high or low point, you’re likely dealing with a choppy market.
This can be visually seen with a rectangle pattern if you put a horizontal line at the high and low points. And the market stays within those moving back and forth.
Traders will also use Fibonacci retracements to help identify a choppy market. Rather than go too deep into this idea, a simple rule is to find a stock that is retracing a minimum of 61.8% (the golden ratio) of its movement three or more times. If you see the bouncing of 75%-100% several times, you have a choppy market.
Trading in a Choppy Market
When you trade in trending markets, you’ll take fewer positions and let the market work for you. However, it’s the opposite for choppy markets. You’ll set lots of positions, and trade high low ranges. There are two methods that can be used to profit in choppy markets.
Buy at Support or Sell at Resistance – when you’ve identified a choppy market, the volume in the market is key. There won’t be enough supply or demand needed to push prices outside the critical high and low points. The goal for a trader is to buy at the support or sell at the resistance points. In return, make profits with the price volatility within that range. If you see that the volume starts to change, this is the sign to get out of choppy market positions. Look to open breakout positions.
Utilize Oscillating Indicators – The use of indicators like the RSI (Relative Strength Index), Average Directional Index (ADX), and Slow Stochastics have been shown to perform very well when markets are choppy. The RSI is one of the most common market indicators and measures how a stock is performing against itself. The RSI compares the strength of the up days versus down days and has a range between 0 and 100. A bull market is indicated when there is an RSI reading of 70 or higher. A bear market is indicated if the reading is 30 or below. When one of these levels(30 or 70) is reached and does not continue higher but oscillates back, you’ll buy/sell. If the indicator goes past 30 or 70 and stays there, the asset is now trending. Being overbought or oversold, and no longer choppy, or the price reaches your leaving chop high or low points, is time to close the position.
Which Indicator Is Best for Ranging Charts?
When you’re in a choppy market, you’re trading within a range. So using the RSI is probably the best range indicator you can use to confirm. Depending on where the RSI is, you’ll know if you’re in a bullish, bearish, or ranging market. Then you’ll know what type of trade to place. Options are a great strategy for range markets. Spreads are good for the choppy market as well.
Let’s Go Through an Example of a Choppy Market
First, we need to be looking at assets that have good volume, high float (if it’s a stock), and good liquidity. You want the ability to get in and out quickly. These assets will be able to indicate accurate movements and prevent market makers who are able to take advantage of you and your stop-loss points.
Our above-pictured example asset fits all of these requirements. We’ve been following it and have defined the high and low exit points (19.00 and 19.55) for a choppy market indicated in purple. Then we see the movement inside retracing 75%. If we’re using our support and resistance strategy, there are several points where we’ll either buy or sell between 19.22 and 19.48. In the end, when we reach our 19.55 to the far right, we close our choppy positions.
When using the oscillating RSI indicator strategy where 2 spots reach (or nearly reach), our “RSI 30 line” indicated with the green circles. The indicator oscillates back in the opposite direction. We may have bought at the first circle as it was close to the 30 but certainly the second. And again closed the position when we got to our high purple point.
As you can see, either method tells nearly the same story and can be used in combination to help make a decision. In the case of the second circle, we reach both a support and pivot point at the same time. Which is a great indicator for a buy which we would ride up to either the resistance point or if we run a bit more risk, the close position purple point.
When to Be Trading Choppy Markets?
For day traders choppy trading is best between 11 am to 2 pm EST. This is because bigger moves usually happen in either the morning or near the close of the trading day when the volume is generally higher. Trading at this time and having proper stop loss points will limit your chances of whipsaw.
Whipsaw is when a recent purchase unexpectedly moves in the opposite direction of the trade resulting in a big loss
Trading a choppy market is not for the faint of heart. Remember to keep stop orders to prevent losing all that you have gained. If a stock has a high beta it is too volatile to trade in a choppy market, and your signals will not be as strong. If you are interested in options strategies for a choppy market, you can look into a short strangle, but this is only for advanced traders and quite risky. As with all trades, only put at risk what you can afford to lose, and we wish you the best of luck with all your transactions.