Regime filter
How do traders decide that the market has changed, and that a strategy should sit out until conditions return?
In plain words
A regime filter is a rule that switches a trading strategy on or off depending on measured market conditions, such as volatility, trend strength or trading volume. The strategy itself stays the same; only permission to run it changes.
Why it matters
Many strategies are built for one kind of market and lose money in another. A filter lets a trader refuse to trade when conditions fall outside the ones the strategy was designed for, accepting fewer trades in exchange for avoiding the ones most likely to fail.
In a real week: BTC, week of 7 June 2021
In the week of 7 June 2021, BTC ranged from 31000.0 to 39380.0, a 27.03% spread, with realised volatility of 99.1% a year. Its worst day was -6.27% on 7 June and its best day +12.0% on 9 June. Volume of 24.9bn dollars sat at 0.86 times its prior 12-week average. A filter set on volatility or range would have classified this as a wild regime and kept a trend strategy idle.
A common mistake
Treating the filter as a forecast. It only describes whether current conditions match the ones a strategy was tested on; it says nothing about which way price will move next.