In this article we are going to discuss non-directional markets, their sources as well as what to do with them. First, however, we need to define them.
So what is a non-directional market?
Imagine you're trading the EUR/USD. After you perform some market analysis, you belive that the currency pair is going to strengthen so you go long on the EUR/USD. Another day, you might believe that it is going to drop, so you would short the currency pair. These would be an example of directional trading because the trader is taking a fairly confident stance on which direction the trend is going to go. In non-directional markets, you'll notice that the trend doesn't take a clear stance; rather, it moves sideways.
Where do non-directional markets come from?
The root cause of the non-directional market is uncertainty. As traders, we understand that the only guarantee in the markets is uncertainty, but this type of uncertainty is different. For example, it’s easy to frame uncertainty during a rate decision – if the rates increase the dollar goes up. If the rates drop the dollar weakens. However, the uncertainty of having one fed meeting after another with conflicting economic data is much more difficult to forecast future movement.
And there is a lot of this type of uncertainty in our world. Just look at the uncertainty we've experienced just with in the past couple years: the uncertainty surrounding the Greek debt defaults, or even the more recent Brexit from the European Union. Geopolitical tensions (such as ISIS, South China Sea, and Ukraine) also make directional bias difficult. At any moment tensions could flare resulting in greater uncertainty.
Adding to the uncertain cauldron, is the presidential race in the US. There is also the dysfunctional relationship between the Whitehouse and Congress, and their inability to settle on any meaningful fiscal policy.
All these factors make forecasting future trends foggy at best.
What do you do in markets like this?
The easiest solution is to use different models. Fading the outside of the range is an effective strategy. Reversals will tend to yield better results than breakouts. Smaller timeframes will still have directional bias – albeit with smaller returns. And taking small incremental profits is better than hitting home runs.
Traders can survive periods of non-direction if we remember the rules are different and it requires a different book of play. Don’t forget the rule of volatility – the market oscillate from periods of high volatility to low. Also, remember that clarity on major news events will bring shifts in the market, so be prepared!