Introduction
Did you ever notice that sometimes the prices of currencies appear trapped, like they are stuck in neutral? This is called a flat market or sideways market, which is defined by prices trading within a limited range with no identifiable trend emerging.
Here's an example: You're watching EUR/USD. It has traded between 1.1000 and 1.1020 for the past five days, going back and forth like a tennis ball bouncing between two walls. That, my friends, is a flat market.
To better illustrate this for beginners, think of a student whose scores in exams continue to fall from the 70-75 point range. With every exam, the student's scores remain in the range of 70-75 points. The student's exam performance is similar to currency pairs in flat markets, in that the performance range can be predictable.
Understanding flat markets is important for forex traders because flat market conditions occur more frequently than one realizes. Learning how to identify flat market conditions and how to trade them will prepare you to take advantage of these, as some would consider, "boring" market conditions, and avoid the traps that inexperienced traders often fall into.
This in-depth guide will cover everything from definitions to trading strategies - we'll use professional forex examples as well as analogies for beginners so the reader can connect with the material on some level.
What is a Flat Market / Definition of Flat Market
The term flat market is also often referred to as a sideways market or even trading range, which occurs when price remains focused within a certain range (between support and resistance levels) without making any significant new highs or lows. In contrast with a trending market, which has observable movement in a (upward or downward) direction, a flat market means the price doesn't move to a point of either reaching or placing a significant high or low; instead, we see horizontal price action with little or no volatility.
Things to look for in a flat market:
- Price Action: Price is bouncing around between two well defined levels - support (the floor) and resistance (the ceiling). In fact, each time it approaches one of these two defined levels, the price/movement quickly reverses direction.
- Volume: Trading volume is typically much less than in any trending phase - less trading interest/participation.
- Technical indicators: A few indicators can help define market flatness, such as:
- ADX - Average Directional Index: a value below 20-25 usually means weak trend or no trend
- Bollinger Bands - Bands will begin to contract as volatility decreases.
- Moving Averages - the support/resistance levels will typically oscillate around moving averages - prices do not stay above or below the moving average for a defined period.
Professional Example: The GBP/USD trades within 1.2800-1.2850 for 10 consecutive days, with an ADX focus of under 20; this symbolizes a flat market.
Beginner Example: You can relate this to a video game player who scores between 2000-2050 points, over multiple times playing this game. This demonstrates stability and distanced performance, but no significant upward or downward direction.
Now, if you can identify flat markets, you are able to utilize the various range trading strategies available. Although trending markets are sexy and receive the most publicity, flat markets produce decent opportunities for traders who respect the conditions that flat markets present.
Reasons for Flat Market
Interestingly enough, it is extremely helpful to know why the market is flat, and to be able to forecast how long the market may be flat, and which potential direction the market may break out. There are quite a few fundamental and technical reasons for a market to go into a sideways or flat market.
The main causes that contribute to Flat Markets:
1. Steady Market Equilibrium Between Bulls and Bears - If buyers and sellers have equal strength and conviction, neither side can seize control. This causes the market to stay in equilibrium and result in a tug-of-war effect therefore prices will remain restrained and within range. When traders are doing this, it is considered "price discovery" by the professionals. Essentially, the market keeps trying to find a fair value by repeatedly testing support and resistance levels.
2. Lack of Major Market Catalysts - Flat markets happen when there are no significant economic signals, central bank updates, or geopolitical events. Traders are not receiving any new info that affects market sentiment which causes them to "wait" or sit back which reduces both volatility and price action.
3. Caution from Institutions - Monetary institutions such as banks, hedge funds, and pension funds sometimes may sit on the sidelines during periods of uncertainty. When these larger players are inactive, the resulting volume and momentum decrease will often create a range bound situation.
4. Technical Consolidation - After a major move in trending prices the market may enter a phase of technically based consolidation to "digest" prior gains or losses. During this phase of technical consolidation, the market has a chance to reform energy for the next major move, while simultaneously providing an opportunity for latecomers to get positioned.
Professional Example: The USD index often has low volatility in price action leading up to Federal Reserve interest rate decisions because traders are taking a cautious approach to trading while waiting for policy announcements.
Beginner-Friendly Example: Think about exam scores that remained steady all week before final exams. The students are focused on revision for the exam, not answering practice test questions, so the performance is consistent and flat.
Acknowledging these underlying causes allows traders to not only scoop when flat markets can happen, but how long they may continue and how they will eventually breakout. This understanding is the basis for developing a viable trading plan for a sideways market.
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