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Most of us spend time developing a trading strategy that is focused on our entry and exit price. Rarely do traders spend much time thinking about how the performance of their strategy will change with different market environments.

The key to adjusting your trading strategy based on the market environment is to understand that there are different market phases. Markets consolidate and are range-bound most of the time, and then break out and trend, approximately 30% of the time. It’s important to monitor the type of market environment you’re in, and have a way to determine when the market environment has changed.

There are four distinct market trading environments, where you could evaluate a specific price to determine if price action is range bound with low volatility, range bound with high volatility, trending with low volatility and trending with high volatility. It can also be divided as the ranging market and trending market.

Range-bound market

A trading range occurs when a currency trades between consistent high and low prices for a period of time. The top of a trading range often provides price resistance, while the bottom of the trading range typically offers price support.

Range bound trading takes advantage of markets that are in a congestion phase and a well-defined trading range.

The chart of the GBP/USD shows market congestion that causes an exchange to trade in a range, until there is an impetus that allows it to move to a different range. This is an example of a range bound market that experiences both high and low levels of volatility. In mid-2016 the currency pair was trading in range 3, and enjoying low volatility until the Brexit vote in June of 2016. The surprise results generated downside volatility and a movement of the currency pair out of a stable range and into range 2. The exchange rate spent approximately 3-months in range 2, until a new impetus moved the exchange rate even lower.

Trending market

The simplest identifiers of trend direction are higher lows in an uptrend and lower highs in a downtrend. Some define trend as a deviation from a range as indicated by Bollinger Band. For others, a trend occurs when prices are contained by an upward or downward sloping 20-period simple moving average (SMA).

A way to determine if the market is trending is through the use of the Average Directional Index indicator or ADX for short.Values more than 25 usually indicate that price is trending or is already in a strong trend. The higher the number is, the stronger the trend.