Trading With The Market

By Steve Palmquist

Learning to trade with the market is a key part of improving trading results. There are many trading systems that work well in some market conditions and not at all in others. There are few, if any, systems that work in all market conditions. Trading results are improved when the trader has a variety of techniques available, and selects the one most appropriate for the current market conditions.

Trading success does not come from finding the Holy Grail; it is the mastery of several different aspects of trading that leads to success. It takes time, effort and money to learn this. Mastering trading, like many other professions is well worth the investment you make.

Figure 1 shows a two-year period in the NASDAQ. Buy and hold investors who bought in January of 2002 ended up in pretty much the same place in January of 2004. Strategies with long holding periods showed draw downs during the first half of the period, and gains during the second half. The net result of holding during the 2002-2004 period was essentially breakeven.

Short-term traders could make profits during the first half of the period shown in Figure One by using effective shorting strategies, and profits during the second half of the period by using effective long strategies. Trading with the Market requires one to have a variety of strategies that are known to work in different Market environments, and a method for determining which strategy to use.

I have developed a number of different scans that find setups suitable for a variety of different market conditions. There are scans that look for long and short pullbacks, volume accumulation, volume distribution, and various patterns. I have tested these scans in bullish, bearish, and trading range market periods; so I know which ones work best in any given market environment. I make a careful analysis of the current market conditions each evening then select the right tool for the job. If you would like more information about this visit or email me at for my current market analysis and trading setups.

Figure 1

The key to selecting the best trading system to use for current market conditions is determine whether the current market is in a narrow trading range, a wide basing area, or a trend. Once I determine what the current market environment it is I know which of my trading tools to use because I have tested each tool in these different market conditions.

I use trend lines on the NASDAQ to determine whether to focus on long or short scans. If the NASDAQ is above an ascending trend line, I select tools that perform well in an up trending market. If the NASDAQ is below a descending trend line, I select tools that perform well in a down trending market. I have also found moving averages to be effective tools for determining which trading tools to use. Backtesting results indicate that several of my systems respond well to limiting Long Entries to periods when the QQQQ is above its 30-day simple average.

When the NASDAQ broke above the descending trend line shown in Figure 1 in March 2003 it implied that it was time to stop focusing on tools that perform well in down trending markets and select another tool. A trend line break does not imply the immediate start of a new trend. It indicates that something has changed; the market may base awhile then resume the original trend or start a new one. In either case the indication that something has changed in the market indicates that the trader must change with it. The way traders change is to change the tools they are using and their position sizing.

After a trend line break I reduce my position sizes. The reason for this is that swing trading in bases carries more risk than trading in trends, so reducing my position sizing is one way to compensate for this. After the March break of the descending trend line shown in Figure One the market bases for four weeks. During this basing period I focus on tools and techniques that have tested well in this type of environment and also continue to trade half size positions. At some point the market will either break above or below the base, and attempt to start another trend. When it does I will trade with the break using the appropriate set of tools.

When the Market is in a clear trend, either up or down, I focus on tools and techniques for Swing or Intermediate term trades. When the Market is range bound as shown in Figure 2, I generally focus on Short Term or Swing trades. The Market conditions tell me which type of trading patterns and techniques to focus on, and the type of trading determines the exit strategies.

Short Term Trading involves taking quick profits on the breakout. I typically exit after 1-2 days, or after a quick pop. This approach can be profitable in range bound markets like that of Figure 2 when the market is only moving up or down a few days at a time. Holding periods of more than a few days in this type of market usually just churn the account.

Swing Trading requires the market to be moving in a large basing range or trending. I place a stop under the low of the setup pattern and close positions as the stock approaches support or resistance. This tends to be more profitable than Short Term trading when the Market is trending or trading in bases that take at least five days to move between the top and bottom of the range.

Intermediate Term trading generally is preferred when the market is strongly trending. I will place an initial stop under the low of the set up pattern and hold while market conditions remain favorable. I will sell when the Stock or the market breaks a key Trend Line or shows signs of topping.

Range bound markets such as shown in Figure 2 are generally poor places for intermediate term trading. Short term or Swing trading techniques can provide better results. In Narrow bases, where the market moves between the top and bottom in less than four days I limit myself to short term trading techniques when the market is bouncing off support or resistance, or stand aside. Narrow ranges require quick, decisive action. I just focus on taking a quick profit on the initial move after a trigger.

Figure 2

When the market is in a wide base where it takes at least five days to move between the top and bottom of the range swing trading can be effective. I focus on entering trades when the market is bouncing off support or resistance and avoid taking trades in the middle of the range. The reason for this is trades taken in the middle of the basing area have less time to work out than ones taken on either end. I refer to the middle third of a basing area as the ‘no zone’, and avoid taking new trades in this area.

Intermediate term trading works best when the Market is in a clear up or down trend. I watch for the break of an intermediate or long-term trend line, or a successful retest of a base breakout as possible beginnings of a new trend. I focus on Swing Trading until the market makes a higher low. After a higher low is established I can draw a trend line and consider Intermediate term trading techniques until the trend line is broken.

In order to use Intermediate term trading techniques, the market must be in a clear trend. An up trend usually is not clear until the market has formed a higher low. Until a higher low is formed it is often safer to focus on short term or swing trading rather than intermediate term trading.

Sometimes the market conditions will allow you to use more than one trading style. When the market channels up active traders may use both Intermediate and Short Term Trading techniques. To use short term trading in a channel focus on entering longs as the market bounces off the bottom of the channel, and taking profits as the Market approaches the upper channel boundary.

Successful traders analyze the market to determine the trading system and techniques most suitable to the current conditions. Ignoring market conditions can lead to significant draw down’s for most systems. It is important to have multiple techniques in the traders toolbox that have been tested in bull, bear, and trading range markets, then select the right tool for the current market environment. If you would like to see my outlook on the current market conditions and trading setups email me at

Author Information: Steve Palmquist is a full time trader who invests his own money in the market every day. He has shared trading techniques and systems at seminars across the country; presented at the Traders Expo, and published articles in Stocks & Commodities, Active Trader, The Opening Bell, and Working Money. Steve provides additional information for traders at and is the publisher of the Timely Trades Letter, email for a free sample.