How to Determine a Sideways Market - Part 1

fullmoon posted an article : 24 Feb.

Dear Traders,

this is the third article my series Bollinger Band Strategy for Trending Markets. In the first article
(December 2014) I described how you get in and out of the trade when we are in a trending market. In the
second article (January 2015) it was all about managing stops and take profits.

In this one, it will be all about how to determine a sideways market. This is the time frame, when we
don’t trade at all, since we have no underlying trend. Don’t underestimate this – staying aside and
waiting for good opportunities is a big part in successful trading.

Te keep things simple and concentrate on the active trades I showed that you are in a trending market
when the middle line of the Bollinger Bands is consistently rising or falling. When this middle line – which
is just a moving average – is flat or directionless, we are in a sideways market.

This all is completely true, but we can do better: In standard Bollinger Band settings the middle line is
a exponential moving average. The parameters don’t matter that much, the key is to keep them on a
fixed level to get the feeling how they move.

Back to the middle line - there are numerous ways to alter that line. Jforex is a fantastic charting tool and
we have several options to set how this “moving average” is being calculated.

I like to pick the EURUSD pair on a daily chart to show the differences. We are all familiar that we had
been on a sharp downmove and went in a directionless market the last several weeks.

Let’s go – first of all I will show you all the charts with different settings and comment them briefly before
we go to the conclusion. I keep all settings at 20/2 which means the moving average will be calculated
with 20 periods and the upper and lower bands set at 2 standard deviations apart.

EURUSD, Daily, EMA - Exponential Moving Average (standard setting) 

With the exponential moving average EMA we get no clue that we might enter a sideways market. The
bands narrow, but this happens often after sharp moves. In fact, early February in week 6 we get a short
entry signal, since the middle line was hit. We would have exited that trade with a profit two days ago. We
notice that the EMA is still falling.

EURUSD, Daily, SMA - Simple Moving Average

The simple moving average SMA does not look much different, it just moves slower, since it the last days
are not weighted like in the EMA before. We would have entered the same trade on the same day, but we
are still waiting for the exit at the lower band, which is right now at 1.12527. We notice that the SMA is
moving sideways and beginning to rise.

EURUSD, Daily, WMA - Weighted Moving Average

The weighted moving average WMA is much more "weighted" to the average price action and we are
already in a clear sideways market since mid of week 7. This keeps us out if any trade.

EURUSD, Daily, DEMA – Double Exponential Moving Average

With the double exponential moving average DEMA we are in a sideways market since end of week 5.
This keeps us out of any trades. But if you take a look on the downtrend we had plenty of entry signals
but our Take Profit was never hit. If I had to trade with the Bollinger Bands and DEMA as the middle line, I
would lower the standard deviation setting from 2 to 1.5.

EURUSD, Daily, TEMA – Triple Exponential Moving Average

The triple exponential moving average TEMA follows the price action very closely. In fact we have
a rising middle line for the recent weeks. If we had to trade the trend with this one, the standard deviation
setting would have to be lowered down from 2 to 1.

EURUSD, Daily, TRIMA – Triangular Moving Average

The triangular moving average TRIMA moves very smoothly. The sideways action since mid of week 7 is
also very smooth and keeps us out of any trades. The big downside is that we can’t use that average for
trading in trending markets at all, since it was never hit and we had no chance to enter any trade.

Conclusion:

What did we learn so far? It makes totally sense to switch around different settings and see how other
moving averages are doing. Whenever you are unsure if to enter a trade and in doubt if we are already in
a sideways market again, switch around. Jforex is one of the best tools when it comes down to change
settings quickly.

I personally like DEMA, the double exponential moving average as it shows changes in trend very quickly.
And also TRIMA because of its smoothness. There is no wondering if the average goes up or down at all.

The key is to find out if we already entered a sideways market as early as possible. This can be done
better with any other moving average than the exponential moving average EMA in the standard
Bollinger Band settings.

There are some more moving averages to choose, but there is a word limit on an article.