How To Trade A Choppy Market

The bulls are making their first major stand in weeks. Almost three quarters of all stocks trading on US exchanges advanced by midday Tuesday.

It was truly a rising tide that lifted all ships. It prompted shorts to cover and sold-out bulls to dive headfirst into new positions. However, it’s important to remember that the market’s not out of the woods just yet…

As a trader, you need to stick to your rules now more than ever. Especially since the market continues to send mixed signals.

Your behavior on days like Tuesday is especially important. A positive showing after the recent six-week drawdown can evoke powerful emotions in traders and investors alike. By following strict trading rules, you can filter out the noise that could cause you to make costly mistakes.

Don’t anticipate the market’s next move – This is your first, and most important task. Analyze the current state of the market. Last week, I annotated a weekly chart of the Russell 2000 for my readers.

Below is an updated chart. It shows this week’s bounce off a key support area:

I told my readers that ideally, we would like to see the markets test this support level and move higher.

At the time, it was impossible to predict what would ultimately happen. The key in a situation like this is to wait and then react to the market’s actions. In this case, the market appears to be gaining support at this level (for now). It has a ways to go before it confirms its April highs.

Don’t chase breakouts and breakdowns – When it comes to sideways and volatile market action like we’ve recently experienced, timing is especially critical to trading success. This is where our next rule comes into play: Don’t chase.

A choppy market will eat you alive if you chase stocks on days like Tuesday… only to get stopped out within 48 hours if the rally fails to hold.

#-ad_banner-#The same holds true for days when the market is falling. If you’re not careful, you’ll be whipsawed out of every new position you take. If this happens, the only one making any money will be your broker…

Adapt your time frame to beat the market – Swing trading could get you in trouble in a sideways market. So unless you are trading with a very short time frame in mind (a projected hold time of less than 5 days), you should probably avoid going 100% long at this time.

For longer-term traders and investors, the market needs to confirm its trend one way or the other before decisive action can be taken.

To combat volatility, you want a strategy calling for a few select long positions comprised of fundamentally sound stocks with favorable technicals. Then add select short positions in stocks that have recently broken support.

This would be wise. Were the market to break in either direction, you would be prepared to cover or sell… riding the new trend to well-deserved gains.