The “good old days” in trading are largely gone but, unfortunately, not completely forgotten by many traders. Back in 1999 through 2001, the day-to-day volatility of the equity index futures market was only rivaled by that of the late 1920s and early 30s. Many traders believed the markets of ’99 to ‘01 would remain at elevated implied-volatility levels for years to come. As a result, they spent as much as they made and did not build their trading capital.

As market activity decreased and electronic exchanges proliferated, these traders had difficulty adapting to new market dynamics that required adapting from a momentum style (where the key is getting filled on attempted trades) to a non-momentum style (where market direction is the key to profitability).

With these new dynamics came fewer and fewer trading opportunities. Aggressive day traders may have found upwards of 10 to 15 individual trades a day throughout 1999 and 2001. Suddenly, those opportunities were cut to approximately 3 opportunities in a day.

The mistake that many traders made was accepting their losses through days, weeks, months and even calendar years while failing to recognize that these losses were a sign of something fundamentally wrong with their trading approach. Instead of adapting, they chose to wait and believe that the market would revert to the momentum style that had been so profitable for them. That decision proved detrimental to many traders’ livelihoods and lifestyles.

Take the theoretical example of a trader with a $300,000 trading account and $100,000 in living expenses, who averaged $500,000 gross trading profits per year over those three years by trading during the momentum days of 1999 through 2001.

Further, let’s assume that this trader never increased his or her capital in that trading account and, with the change in market dynamics, suddenly experienced a year in which -- after expenses -- he or she lost $40,000. All of a sudden, this trader was faced with trading capital that shrank by a third! With this shrinkage came the psychological burden of the failure to generate income and the natural fears about whether he or she would be able to survive into the next year.

Typically, what happened to many traders faced with this scenario was that they did not cut back their trading activity. Instead, they made more and more decisions in a day. In a market that might have moved 7 S&P points (or 0.5%) in a day, they found themselves participating in upwards of 25 to 30 trading decisions.

They created support and resistance points intraday at levels that were simply where they bought to go long and sold to get out of losers and vice versa where they sold to go short and bought back to cover their losses. This unfortunate story was very common and resulted in the weeding out of a large percentage of local traders in the pits and professional day traders throughout the country, all of whom became former traders.

Today, we experience the volatility that was common in the years 1999 - 2001 on only approximately 10% of trading days. If we look at 2005, we had 3 busy days to start the year, a volatile move in April that lasted approximately 5 days, moderate volatility in 2 periods in March and May and, more recently, have seen a volatile move for 5 out of 7 trading days in early to mid-October. Unfortunately, for traders who have been unable to adapt, the non-momentum-style market conditions in the rest of that period has proved unsatisfactory.

The key to survival for a trader is to use some of the momentum techniques appropriate for the volatile days, but, then, quickly recognize the shift in the market and switch to a non-momentum strategy once the volatility cycle ends. Otherwise, the danger is that they will commit the mistakes of the past over and over again: Viewing the market as an “ATM” that generates cash and spending trading profits.

Traders don’t have to lose a large sum of money to face this problem; it can occur just because they draw upon their trading capital to live until they gradually lose confidence that they can no longer successfully trade.

The key to adapting to this new environment is to be flexible with your approach and / or create trading approaches that are flexible while maintaining sufficient discipline with your trading capital, business plan and / or personal financial so that you can put money away for quieter times.