Traders are told to stick to their strategy through good times and bad, but we also hear that traders need to adapt to current market conditions. Which is it? This article sets the record straight and tells you how you can be adaptive while also following your trading system.

Utilize an Adaptive Trading System

If a strategy isn’t working, there is little point in continually hammering trades hoping that eventually it will work. Many traders, who were at one point successful, have gone broke with this approach.

This is why I believe in developing adaptive trading systems. This way, you can follow your system, but market conditions tell you whether you should be trading or not, and how aggressively.

On this note, an element that is missing from most of the trader’s strategies that I coach is that they have entry rules but nothing that tells them when they shouldn’t be trading. They are continually following entry rules even though market conditions are not good for those entries. In essence, they have only developed a half strategy. They have not looked at under what conditions the strategy performs well and poorly. So they take trades through all conditions, when they should only be implementing the strategy under conditions where it performs well.

How to Develop an Adaptive Trading System

Every strategy I develop is adaptive, or at least appears adaptive to outsiders, because it includes rules that tell me under what conditions I can trade and when I need to sit on my hands.

This is what is often referred to as “context.” Context is what is happening around the trade signal, and is as important as the trade signal itself.

For example, when I swing trade stocks, in order to go long on a swing trade, overall stock market conditions must be favorable (indices moving up, more than 50% of stocks above their 50-day moving average, follow-through day has occurred, NYSE Advance-Decline line holding up well).

Why? Because the wind is at your back. If most stocks are moving up, it is far easier to make money than if most stocks are flat or dropping. Since I trade stocks that are very strong, buying stocks with a huge amount of buying interest while most stocks are moving up anyway is like fishing with a grenade in a small pond. That is not to say I don’t have losses. I do, but it is so much easier to make money when you are placing trades when conditions make it likely you will be profitable anyway; your strategy just becomes an odds enhancer, or a method for bagging profits that are larger than “average.”

Most people keep buying long after market conditions have turned bearish. If they did happen to make money on a rally, the give it all up on the decline. If you know when not to trade, you avoid this vicious cycle.

I once wrote an article on shorting stocks for Investopedia, and I said that I only shorted stocks that were already in downtrends and falling significantly. Someone commented “Anyone can make money in a stock that is tanking. Tell me when the stock is going to tank!” This person was missing the point…and the money. They were making trading much harder than it has to be. They were trying to have perfect timing. They wanted to short as prices were rising or just at the top. They wanted to go against conditions. Much easier to wait for the downtrend to start, for emotions to get high and for people to panic sell, and then ride along. No need to predict what’s coming. Trade what is.

My Complete Method Stock Swing Trading Course covers which conditions to trade in, as well as red flags to help you avoid common traps—trades that look good but are highly likely to fail.

Examples of Adapting a Strategy to Market Conditions

In this section, I will go through several examples of how my trading strategies adapt to current market conditions. This saves me from losses when conditions are not ideal for my strategies, and makes me money when they are.

How do we know what conditions are good, and not, for our strategies? We look.

I review my trades and notice when there are common traits in a majority of my losses, or when certain traits are common in a wide majority of my wins. Much of this happens in strategy testing, just going through charts. But it also occurs once I am live trading. I notice that certain conditions or price movements cause me to lose more trades, I note that, and put it my trading plan to avoid those trades. This way, I am adapting, but also following my plan.

These examples are just a sampling of ways to adapt. There are many things that happen on the chart (or in my head) that cause me to trade differently than my basic strategy lays out.

Adapting to Conditions While Day Trading

I have noticed when certain conditions materialize it is very easy to make money, and when other conditions materialize it is very hard to make money. Here are some examples.

• When there is little movement, it is hard to make money. So my rule is that prior waves, that occur before my trade trigger, must be big enough to easily reach my profit target. If they aren’t, I don’t trade.
  
  The following chart is an example. I am taking a long trade based on a rounded bottom pattern. The wave coming into the pattern was 7.8 pips from a similar trigger to what I want to use for my trade. The wave just prior to my trade was also 7.8 pips. My target is 6.3 pips. Waves are big enough to reach my target. So this is not an issue. If prior waves were only 5 pips, then there is a big pullback or reversal, going for 6.3 pips is a no-go; not enough movement.

• If the price is approaching my trade trigger, but is whipping up and down, then it will be very easy to get stopped out. I avoid these trades. If price is already whipping up and down before I enter, why will the price all of a sudden move in my direction after I enter? It may, but it is a gamble. Price is not moving definitively, so I stay out.
  
  The chart below shows a couple of examples of this. Keep in mind I like to use tight stop losses (see chart above) because it actually allows me to maximize profit, so whipsaws are not good for that.
  
  Note my first comment where I say “Pretty nice. A little whipsawy coming in. Optional.” As that pullback is developing, notice how the candles have long wicks. They drop and then spike back up, then drop, then spike. Ultimately it keeps dropping, so that isn’t so bad. Some days I take that if I am feeling more aggressive, other days I don’t.
  
  Then note my big comment at the top where I say “So easy to get stopped out…” As the price is climbing up toward my arrow, there is a green candle that drops and then moves up (visible by the wick). Then a little green bar and then a red bar that drops followed by a green bar that spikes up. We have bars whipping around but not progress being made. Do I want to enter there? NO!

Now, below we have a trade where neither of these poor conditions are present. There is lots of movement compared to my target (which was 2.3:1 reward:risk). The price moves swiftly to the upside, small pullback with no whipsawing around, and then price starts moving to the upside and I enter. This is what I call a “clean setup.”

Similar concepts apply whether day trading stocks, forex, or futures.

There are more things to consider as well, but these are a couple of examples of how we adapt (trade or don’t trade) based on the price movements that are occurring around a possible entry signal.

My Price Action Stock Day Trading Course covers which stocks to trade, the type of movement you are looking for to maximize your chance of successful trades, and situations where you want to avoid taking trades. Find high-quality trades in less than 30 minutes a day.

Adapting to Conditions While Swing Trading

I already discussed one way I adapt my swing trading to current market conditions. I don’t go long if most stocks are declining. I only short if the indices are falling, and I only go long if the indices are rising.

Let’s look at one more example.

• Similar to day trading, wave size needs to be big enough to give me a good reward:risk for my stop loss size (at least 3:1 or more for swing trading). If price is rising 5% and then getting choppy, and then rising 5%, and then getting choppy, I don’t want to use a profit target of 5% or more. Then I will likely need to hold through a rally, chop, and then hope to get out on the next rally. Much easier to make money if is rallying 20%, then getting choppy or pulling back, and my target is 10% to 15%. I am trading “inside” what the market is already doing.

Below is a trade I liked (still ongoing; no idea how it will turn out). The price is making big up moves (and I can still measure the prior moves, even if I wasn’t trading them or even watching the stock). The stock rallied 87% and 52% coming out of prior rounded bottoms. I started watching this stock in late July. In early August it formed another rounded bottom (and also a contraction pattern). I entered with a 40% target and a 10% stop loss. 4:1 reward:risk and even though I am going for a 40% target, the stock is more than capable of running 40%, evidenced by prior moves. That doesn’t mean it will hit the target, but certainly better than if the stock was making tiny moves and I was simply hoping it would all of a sudden make a bigger move just for me.

Our target is adapting to market conditions. If the moves were only 12%, then my target should be about 9% or less (which means the setup needs to provide an entry where I can place a stop loss within 3% to give me 3:1).

This trade ended up just barely getting stopped out and then running to the target. That’s fine. Losses happen. And obviously the target was fine because it was hit shortly after. Can always re-enter if your system allows.

Here is another one. At this time, market conditions were ok, but not great, so there weren’t many trade setups. But this one was nice. Conservative target of about 12%, and since the stop loss was small that provided a reward:risk of 4.7:1. Could have even used a bit target and that would have still been within the norm recently.

Price has been running quite well. Note that I didn’t measure waves from the bottom of the wave, because for this trade I am not buying near the bottom, I am buying once it moves up somewhat, and then breaks out.

• If a chart looks too messy (lots of whipsaw price moves) or has too many gaps, I don’t trade. Maybe the stock will go my direction, but if the pattern doesn’t jump out at me, or the trend or pattern isn’t clear, I don’t trade.
  
  The chart below is an example of this. The stock had a big move up in late June (a gap). It then forms a contraction pattern. A pattern I trade. I want to like this trade, but when I look at the contraction (between red lines) the price is whipping up and down. Long wicks in both directions. If I buy, even ONE more candle like that could stop me out. No thanks. The price did end up going up a bit, but I am perfectly happy to await a pattern I like better.

Other Ways I Adapt My Adapt My Strategies

Sometimes I let trades hit my stop loss or target. Other times I use a trailing stop loss or manually exit.

To outsiders, my decisions may seem random if they review my trades. The decisions are not random.

Once again, there are things I am watching for before and during my trade. How the price moves affects how I handle the trade.

It is still a strategy. If X happens I do Y. If Z happens I do W. If B happens I do A. If C happens I do D.
I am still working from a planned-out strategy in that I know what I will do in various situations.

I discussed many of these situations in Scenario Planning to Improve Trading Performance.

For example, let’s look at an example using several of the concepts already discussed in this article. Assume I am day trading and the price has been pretty choppy for the last hour. I am sitting on my hands because of the rules discussed above.

Then all of a sudden there is a big price wave and a nice setup forms after it. We now have movement and a nice “clean” looking setup. Do I take it? Yes, but I can’t forget the price has been choppy even though we just had one big wave. We could go right back to chop (it’s shown that tendency already).

So I take the trade, but once I am in, if I see signs of chop (small waves, whipsaw candles, failure to progress) again I will just get out. I plan this before I even take the trade, and it is already in my trading plan how and why I will do it.

Essentially, I am entering the trade because big decisive movement came into the market. But if that ceases, the reason for my trade is no longer present. I don’t want to trade in chop, so I exit if the price action gets choppy after my entry.

That is not a violation of my rules, it IS my rules. My strategies adapt to market conditions and are pre-planned to do so.

Here are a few more ways I adapt:

• If waves are getting smaller in the direction I want to enter a trade, that makes me more cautious. I either avoid the trade or must use an aggressive training stop loss because the evidence says momentum is slowing.
  
• If the price is stuck in a range, I trade within it if there is enough room for the target inside the range. Once a breakout occurs, I must wait for a wave to stay outside the range.
  
• I don’t place day or swing trades right before major news announcements, even if I see a great trade setup.
  
• I am even allowed to adapt my trading to my mental state. A simple example is that I don’t trade if I am not feeling well or feel too amped/overconfident/angry/anxious.
  
  A more complex example is that I can adapt to my own emotions while trading. If I am really struggling to hold onto trades on a particular day, for example, and am getting out at poor exits, I am allowed to adjust to maximize profit. For example, I can use small targets, or trailing stops on all my trades in order to compensate (see Oct 22 session recording). But in this case, after my session, I must do some mental work/digging into why my mental state was an issue, and work to resolve it.

Hopefully, this starts to show you the attention to detail that trading takes. Or at least the detail I have put into it. Just hammering away at trades probably won’t get you the results you want, until you start digging into finer details. Each little detail reduces your losing trades or increases your winners, incrementally. The fine details take you from breakeven or losing to profitable, or profitable to more profitable.

Adapting With a Mini-Backtest

When I pull up a chart for swing trading or day trading, I want to see if my methods and my trade triggers have been working. It gives me a sense of how aggressive I can be. If I pull up a chart and there is a nice setup forming, but looking back that stock has never moved well out of a pattern like that, do I really want to trade it? Probably not.

Unless something is much better about this particular pattern/situation (more movement, has broken out of a long-term choppy period, or something like that) I don’t see any reason to assume that all of a sudden the pattern will start working in that stock when it hasn’t in the past. Most likely, if the pattern isn’t working some of the things discussed above are amiss. The mini-backtest helps notice them.

When I start my forex day trading session around when New York opens, I look back at the price action that happened over the last several hours. It gives me an idea of how tough the conditions are. If nothing has been working, that is usually because of low movement or choppiness (discussed above) so I know to be very cautious or not trade at all until I start to see trade signals working. Once again, the mini-backtest helps me notice these things.

Day trading stocks is a little different. I watch from the open onward. The pre-market and the end of the prior day don’t tell me much so I ignore them. In other words, there is no prior price action I can study at the open. But I still do a mini backtest, in a way, once the stock opens and the price starts moving. I can still study how swiftly and decisively price is moving. If triggers have formed (not necessarily attached to a valid pattern) I can see how price is moving off those triggers. If it isn’t moving well off triggers, then it is probably too choppy for me to trade. If the price is moving decisively off triggers, then I am more likely to take the next trade setup I see, assuming it fits all the criteria.

When day trading, I do this mini backtest throughout my trading time. Just so I am aware of how things are working and how price is moving.

This is just one more way that I become aware of the environment in which I am trading, and I am allowed to (and must!) adapt to the information that environment is providing me with.

Final Thoughts on Adapting a Strategy

Trading a strategy and sticking with it doesn’t mean the strategy never changes! It should change! You should always be trying to make it better by looking at your trades, or looking at chart examples of trade setups, and noticing when you tend to lose and when you tend to win.

Continually improving doesn’t mean you will eventually win all your trades. You just improve compared to what you were doing before.

Eventually, you reach a point where you trade a strategy very well because you know exactly when to trade it and when not to. There may be minimal room for improvement at that point. In that case, if you still want to make more profit, you will need to add other strategies to your trading plan.

Each strategy I trade has gone through this process of refining. All the while I am following the strategy in front of me. I don’t change rules while I am trading. I make notes during my review session (outside live trading), verify my findings, and then update my strategy. Going forward I strive to incorporate those updates.

That’s how you adapt a strategy to changing market conditions. It is a continual process until you can confidently handle any situation the market throws at you because you have seen it all before and have rules for it.

The EURUSD Day Trading Course covers various scenarios for when to trade and when not to, so you trade with maximum efficiency.

Cory Mitchell, CMT

Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.