What is Range trading?
It is said that the market only trends for 30% of the time. So it becomes necessary to have a range trading strategy to take advantage of the other 70% of the time. Range trading is not difficult, but it requires discipline and determination to make most out of it. When a market is trending, it forms a pattern of higher highs and higher lows, in case of an uptrend. The move, in this case, is really strong and is known as an impulsive move. The other type of movement is known as the corrective move, which comes in the form of a pullback. Impulsive moves are stronger than corrective moves.
When the market is making any such moves, it finds itself stuck between a high or low and continues to oscillate between these two points. It means buyers and sellers are equally strong, and this creates a very choppy environment.
Traders now trade these extremes and continue to trade until price breaks out on either of the sides. These two points act as potential support and resistance points, used by traders to place their orders.
In the above chart, we have drawn a few lines from where the market bounced off. The price action in those areas creates many trading opportunities. The instrument in the chart first trends down and then puts up a low (marked by line 1). Initially, you might think it as a downtrend and expect the pattern of lower lows and lower highs to continue.
Then you see the market rally to line 2, from where the market falls back to line 3 but does not fall till line 1. This highlights the fact that the market is no more trending. The market instead could be stuck in a range between line 1 and line 2. These are not ‘defined’ prices. Always consider them as zones with a margin of error both outside and inside the range. A trader will look to position himself/herself at these zones of support and resistance that forms the range.
Why support and resistance?
The price that is stuck between these two extremes has a lot of significance. This is because, at this point, the price can either Stop, Reverse, or Breakout. When you have the right knowledge, it will stop you from simply pushing the buttons and will make you trade with a defined strategy.
Range = Consolidation
A range is nothing but a price consolidation of the overall trend move. It could either end the current trend or cause a reversal. The different price behavior pattern in the range creates many trading opportunities, which can be traded by all types of traders, depending on their risk appetite. Now let’s discuss some important trading strategies using support and resistance of ranges.
Strategy Using Technical Indicators
Using technical indicators to trade can aid your trading strategy. Especially while trading ranges, many indicators can be a part of your trading plan. Here, we have used the Stochastic Indicator as a tool to trade the ranges.
In the above image, the two lines represent the support and resistance of the range formed. When the price reaches the resistance at point 1, the Stochastic enters the overbought area, and the slowdown in momentum is the confirmation signal for a sell. The resistance pushes the price back to support (point 2), but this time the momentum is very strong, hence no entry. The stochastic also does not enter the oversold area clearly. Next time the price goes to resistance with greater momentum, and the Stochastic too does not give an entry signal as it is not in the overbought area. This means one shouldn’t be going short at this point.
Overall, there is only one risk-free trade available in the above chart, and that is at point 1 (short).
Firstly, we should be able to see the price at one of the extremes. When that happens, the indicator should show either be at overbought or oversold conditions. The momentum of the price should be an important factor that determines our entry. If we see reversal patterns, this could be the best entry with a good risk to reward ratio. Do not forget to place protective stops much below or above the support and resistance levels, respectively. This will always protect your trades from a false breakout.
When not to buy at support and sell at resistance in ranges
You must have probably heard traders saying that more time a level is tested, the stronger it becomes. This is not true in the case of our range break-out strategy. You need to start paying attention to the price patterns at these ends. If the price has made multiple touches, it could be getting ready for a breakout in the direction of the higher time frame.
The above chart is an example of such a scenario. It shows a range, and at point 1, you can see the strength in the candle as price pushes towards the resistance area. The next push makes the price to consolidate at the extreme. It appears to be a battle between the bulls and bears. It is also making higher lows as a part of the uptrend. Hence a breakout after this point is not surprising.
You don’t want to see the higher lows at the resistance extreme and lower highs at the support extreme.
The resistance could still work, and a reversal could happen, but this type of price action does not give much confidence for shorts. Only aggressive traders may find some entry in that consolidation, for a potential long. They can put a protective stop below the higher low that was formed before the accumulation.
We hope you find this strategy informative. Let us know if you have any questions in the comments below. Cheers!