Book Reviews, Trading

Book Review of Trading Regime Analysis by Murray Gunn

The full title of this book is Trading Regime Analysis: The Probability of Volatility by Murray Gunn (2009).

According to the bio, Murray was a money manager trading in primarily the FX markets. He advocates trend-following, and the book’s main idea is most strategies work, the key is to be able to identify the environment the market is in right now, so as to deploy the right strategies or adjust your risk sizes accordingly.

First off, I have to admit that I have not read this book fully, or in detail. The book is a whopping 400+ pages (whopping for a trading book) and I have only skimmed through it to pick out information tidbits. From my review, there are two broad content areas in the book. The first area covers chart patterns and candlestick patterns that signal a range trading market. The second area covers various indicators that can be used to quantify how trendy / range-bound is the market.

While the idea of deploying the most appropriate strategy for the market at all times is very appealing, this problem of flexibly adapting trading strategies to market conditions is a tough nut to crack. The most common problem is that by the time one detects that a market is trending, the trend might be about to change, or the most juicy part is over and the risk to a trend following strategy has greatly increased. The same thing occurs when you detect that a market is range-bound. If you wait for confirmation of your hypothesis, you might be too late. If you don’t wait for confirmation, the accuracy of your hypothesis would be lowered. How does one classify the market moving forward with high accuracy, early enough such that the bulk of the meat is still available to grab? Does it necessarily mean that a strategy based on trading regime changes should necessarily be a longer timeframe strategy so that there is still decent meat left after a regime change is detected?

There’s definitely a lot of finer details to work through to come up with a good trading strategy based on regime changes. While not covered in the book, I think the indicators and patterns that Murray has shared would definitely help speed up the reader in his/her journey.


FX Markets Are One of the Least Efficient Markets

  • An efficient market requires participants to be profit maximisers. In FX markets, the Governments smooth out fast moves, corporations buy/sell for import/export purposes, so transactions are taken for many different reasons.
  • Hence, information seeps slowly into the FX markets, and this explains why FX markets show a greater deal of persistence (or trend) more than other markets.


Everything Works… Some of the Time

  • By analysing the probabilities of what trading environment or “regime” the market is in, or about to be in, can enable you to adjust your trading or investment risk parameters and game plan in such a way as to increase your chances, your probabilities, of long-term success.


  • Volatility generally peaks after a trend in the price, and generally troughs before a trend begins.
  • Volatility mean reverts, and it can do so in a very fast and furious way.
  • Volatility clusters, i.e. there is a tendency for big moves to be followed by other such big moves, and similarly, for small moves to be followed by other such small moves.
  • Volatility = standard deviation of price, not of price changes
  • Volatility of volatility does not add much value.


Orthodox Patterns: Range-Trading Within the Pattern, Trend-Trading After Breakout

  • Ascending triangles
    • Generally bullish, range-bound regime within triangle and switches to a trending regime at breakout.
  • Descending triangles
    • Generally bearish.
  • Symmetrical triangles
    • Psychology is one of complete uncertainty.
  • Rectangles
    • Buyers and sellers in fierce competition within the rectangle range
  • Flags
    • Scaled down rectangles. Range-trading regime that comes after a strong trending move, and that normally leads to a continuation of the trend.
  • Pennants
    • Scaled down symmetrical triangles.
  • Broadening patterns
    • Good opportunity to trade the range.
    • Edwards and Magee point out that broadening bottoms do not occur in stocks because the psychology behind the pattern is suited only to tops (i.e. a very excited public getting involved near the top of a trend). The eventual break (to the downside for a broadening top) should provide for quite a strong trending regime.
  • Head and shoulders
    • Trend exhaustion and reversal pattern at the end of an uptrend.
    • Period when the H&S pattern is forming, is more often than not a range-trading regime.
  • Reverse Head and Shoulders
    • Trend exhaustion and reversal pattern at the end of a downtrend.
  • Double tops and bottoms
    • Signals an important trend reversal that will usually be accompanied by a strong trending regime.
  • Rising wedge
    • Market is fighting for its life to delay the inevitable decline. It becomes harder and harder for the market to rally but it does continue to make slight new highs.
    • Usually occurs around major turning points and at the end of long trends.
  • Falling wedge
    • Opposite of rising wedge. Demanders eventually win out against the powerful but ultimately limited suppliers.

Candlesticks: Patterns Signalling Range-Trading

  • Doji
    • Psychological state of uncertainty.
  • Engulfing / Outside bars
    • This pattern must appear after a preceding trend in the price.
    • An outside bar would have taken out the stops of both the bulls and the bears, with no follow-through. Hence both sides become less confident and this leads to range-trading behavior.
  • Hammer bottom
    • After a downtrend, the market opens near to the previous close, drops a lot, before closing the period up towards the level at which it opened.
    • Signals an end of the downtrend where the next period will be characterised by range trading.
  • Shooting star
    • After an uptrend, the market opens near the previous close, rallies a lot, but closes the period down towards the level at which it opened.
    • Signals that that supply and demand have become more balanced, and this balance can mean range trading.
  • Hanging man
    • After an uptrend, market does not rise much but falls a lot, before closing back up near to the level at which it opened.
    • This is bearish, and represents the last buyers getting into the uptrend.


  • Increasing volume on breakouts signal the beginning of a trend.
  • Low volume on breakouts signifies mean-reverting behavior.
  • Volume spikes after trending moves (i.e. capitulation) signal either trend exhaustion (i.e. trend will reverse) or the market will go into a period of range trading.

Previous Highs and Lows

  • Zones of longer term significant previous highs or lows can act as areas where the psychology of market participants can change from being confident to less confident about market direction, and there from the market being in a state of disequilibrium (or trend) to a state of equilibrium (or range).

Round Numbers

  • Round numbers act as attractors for market participants.
  • DJI hit 100 in 1906 and took 19 years to get significantly away from that zone.
  • DJI hit 1,000 in 1966 and it took 19 years to move significantly up past that zone.
  • DJI hit 10,000 in 1999 and it moved significantly away from that zone only starting 2011.


Elliott Wave Principle

  • Basic Elliott Wave pattern consists of 5 impulsive waves (1-2-3-4-5) followed by 3 corrective waves (A-B-C).
  • When you see five clear impulsive waves up or down (i.e. a trending, impulsive regime), then you know that the next phase will be a consolidation in the price action (i.e. a ranging, corrective regime).
  • A way to confirm that a range-trading regime could be developing is to look for wave overlap as this will generally occur in corrective waves. Corrective waves are range-trading regimes and will therefore show a sideways trend. Impulsive waves are trending regimes and will therefore show very shallow corrections.

Moving Average Envelopes

  • Take a moving average, and plot a line a fixed % above it and plot another line a fixed % below it (e.g. 21-day moving average with an envelope of +/- 1% above and below the moving average).
  • If the market is trading within the bands, in all probability, this results in a range-trading type of price action. If the market is trading outside the bands, then the market price action is behaving in a strong trending fashion.

Bollinger Band Width

  • Bollinger Band Width = (Upper Band – Lower Band) / Middle Band.
  • Market tends to trade within a range when the band width is falling, and the market tends to exhibit trend-like qualities when the band width is rising.


  • Higher the ADX, stronger the trend. ADX above 25 indicates a market that is strongly trending. ADX below 20 indicates a market that is not trending.
  • A switch from a range-trading regime to a trending regime is more plausible when ADX is trading at a low level.

Rate of Change and Divergence

  • E.g. plot a S&P 500 monthly chart, with a 10-month ROC indicator. When the ROC is above +10% or below -10%, the market is in a trending mode. When the ROC is within -10% to +10%, a range-trading regime is in operation. For a weekly timeframe, a +/- 5% cut-off would be more appropriate.
  • Price divergence with a momentum indicator indicates trend exhaustion. That might mean that price trades sideways for some time before taking off again in the same direction. A sideways market is more probable than trend reversal.

Markov Chains [Interview with RBS]

  • Three price regimes: uptrend, range, downtrend
  • Two volatility regimes: high, low
  • Used 1,000 days of historical data to calibrate (two years of data is not enough, four years is enough for results to be stable).
  • Towards the end of a trend, intra-day volatility can often increase. Using daily close data or implied vol data is not sufficient to pick up the early warning. RBS used a 24-hour volatility number based on 30-minute sample data.

Hurst Exponent

  • Measures the strength of the trend and the level of noise, by examining the level of persistence or anti-persistence in the data. E.g. use a 25-period Hurst Exponent on a weekly EURUSD chart.
  • Hurst Exponent > 0.5 means the data is persistent, < 0.5 means it is anti-persistent.

My MATE (Moving Average Trading Environment)

  • MATE = Difference between 5- and 40-week moving average, expressed as a %. Cut-offs are set at +1% and -1%. (e.g. 5-week MA is 1% above or below the 40-week MA).
  • If the indicator is above +1%, an uptrending regime is assumed to be in force.
  • If the indicator is below -1%, a downtrending regime is assumed to be in force.
  • If the indicator is between 1% and -1%, the market is deemed to be in a range-trading regime.

Trend-Following Performance Indicator (TFPI)

  • Have a hypothetical system that goes long when the closing market price is above the 21-period moving average, and go short when the closing price is above the 21-period moving average. It will always have ether a long or short position in the market.
  • If the equity curve is above its 10-period moving average, the trend-following system is making money, and the market must be in a trending regime.
  • If the equity curve is below its 10-period moving average, the trend-following system is losing money, and the market is in all probability, in a range-trading regime.
  • Calculate a 20-period moving average of the difference between the equity curve and its 10-period moving average.
  • For all oscillating-type measures, wait for it to stop going up before acting in any contrarian manner. This avoids standing in front of the speeding train.

Trading Regime Indicator (TRI)

  • Calculate the 20-period standard deviation of a price series (closing prices), calculate the 200-period moving average of that standard deviation, and examine the difference between the two as a % (e.g. what % is the standard deviation above/below its moving average).
  • TRI > 0 indicates a trending regime is in existence.
  • TRI < 0 indicates a range-trading regime is in existence.
  • Lines at +50% and -50% levels indicate where the regime could be considered to be in an extreme mode (i.e. extremely strong trend or extremely persistent range).
  • Use the TRI on at least one time fractal above the fractal that you are actually trading the market.



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