Talking Points:
- Traders are often best served by using the strategy most applicable to the prevailing market condition
- Ranges occur when prices are caught between support and resistance
- In this article, we teach traders how to approach and trade range-bound market conditions
In our last article, we looked at Trading Breakouts, and in the article before that we showed you How to Build and Trade a Trend-Following Strategy. In this article, we’re going to address the market condition that comes up the most often: The Range.
There is a reason we saved this condition for last. Ranges can be difficult to trade, and many traders will eschew ranges to trade in trending or breakout conditions. As we explained previously, trends display a bias that the trader might be able to latch on to; and breakouts offer massive upside potential when they work… but ranges don’t offer either of these features.
Ranges take place when prices find themselves caught between support and resistance. And when this happens, traders can address the range on one of two ways. They can trade for the range to continue, which means that up-side is limited (by the other side of the range); or they can look for the eventual breakout from the range that may turn into a new trends. The picture below will illustrate further:
Do you want to trade the range to continue, or to look for the breakout?
Image taken from Trading the Break; prepared by James Stanley
If you want to look to trade the breakout from these range-bound periods in the market, please take a look at the article, Trading the Break in which we teach traders to do just that. In this article, we’re going to further investigate the art of trading the range.
Trading Ranges
Many traders will ignore ranges because the perceived profit potential may be limited. After all, if we’re trading a range by buying support, then we’re reasonably looking to close the position at resistance. This would be a limited-upside type of proposition, and that may not seem nearly as attractive as a trend or a breakout where the trader can potentially look for 3 or 4 times their risk amount if they’re able to get on the right side of the trade.
But, the range is the market condition that we, as traders, will likely encounter the majority of the time.
Ranges can develop in numerous ways. We may see a short-term range towards the top of an up-trend, as buyers and sellers fight to control the next trend. Or perhaps a long-term bout of indecision creates congested price movements that stay bounded between support and resistance levels. Whatever the context might be, if prices are bound between support and resistance then the trader is seeing a range-bound period in the market.
And if the trader is going to trade for the range, then they need to make absolutely sure that they manage their risk properly; because a breakout moving in the opposite direction of the trader’s position can amount to a monstrous loss as that breakout may turn into a new trend that continues to drive against the traders equity line.
Trading Ranges requires stops in the event that a breakout takes place against the trader’s position
Image taken from Trading the Break; prepared by James Stanley
How to Find and Trade Ranges
The goal when trading ranges is similar to the goal when trading trends: To buy low, and sell high.
The only other real requirement for a range is that price action needs to be bound between support and resistance, giving the trader the idea that if previously established support and resistance remain respected, the trader may be able to see a profitable position.
One of the difficult aspects of doing this is that prices will rarely adhere to an exact identical price as support or resistance; and often ‘zones’ around supportive or resistant prices are much more applicable. This is where price action analysis can bring considerable benefit to the trader.
We discussed how traders can look for and trade ranges with price action alone in the article, How to Analyze and Trade Ranges with Price Action.
In the article, we teach how you can use recent price action to produce a strategy with a technical setup such as we’ve outlined below:
Zones of Support and Resistance can make trading range-bound conditions more feasible
Taken from How to Analyze and Trade Ranges with Price Action
Traders can also look to incorporate additional elements of support and/or resistance in the range including pivot points, Fibonacci, or psychological whole numbers; but it’s important that traders have seen a price action swing around that particular price, thereby validating that level as a price with which the market has respected, and may respect again in the future.
Taking Range-Trading a Step Further
No range lasts forever. Breakouts come from ranges, and breakouts can lead to new trends. So traders can use this information to their advantage when trading in a range.
Let’s say, for instance, that a trader buys support with anticipation of a range continuing. But when prices move to resistance, the trader takes a second look at their profitable position, and decides that they may want to stay in the trade in case a breakout takes place to the up-side.
Well, if the breakout doesn’t come in, and if the range fills in as the trader had originally anticipated; they can watch all of their profit drain away and maybe even more if the trade runs to their stop.
This would be a bad way of trading a range.
What can be done, however, is some position management in the event that a breakout may occur. Rather than closing the entire lot when the price moves up to resistance, the trader can look to close a portion of the position so that, if prices do reverse – at least they’ve taken some profit out of the trade. But if the breakout takes place, they have a remaining part of the position that can reap those rewards.
This would be similar to scaling out of the trade, and if the breakout happens to turn into new trend, the trader can go into the new trends with a hearty profit floating in the trade, which can be used to initiate a new position in the event should the trend continue.
Traders can also look to adjust their stops to break-even, so that if the breakout doesn’t turn into a new trend, and prices reverse – the trader can be taken out of the remainder of the position at their original entry price.
-- Written by James Stanley
James is available on Twitter @JStanleyFX
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