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Range trading strategies help investors exploit lucrative opportunities when there is sideways price action in the market. Markets oscillate between trends and ranges, and it is essential to have effective strategies to take advantage of trading opportunities during different market conditions.
In a ranging market, prices bounce off defined support and resistance levels, creating multiple buy and sell opportunities for traders. Range trading strategies help traders identify valid range bound markets and optimal price entry and exit levels that offer attractive risk/reward propositions.
Nonetheless, range trading strategies are not ideal for all market conditions or even in all ranging markets. In a trending market, traders apply trend trading strategies to capture profits when the price advances in a single direction.
Breakout trading strategies are also implemented in some ranging markets (especially when there is low volatility) to take advantage of the emergence of new strong trends when high volatility returns.
How to Trade Range-Bound Markets?
The idea in a range-bound market is to identify support and resistance levels, from which prices bounce back and forth. When the price is at or near support levels, the principle is to look for opportunities to place buy orders. When buy orders are placed, resistance levels serve as optimal price target areas.
On the other hand, when the price is at or near support levels, the principle is to look for opportunities to place sell orders. Support levels serve as optimal price target areas when sell orders are placed.
Because range bound markets usually do not make significant price movements, it is crucial to time the optimal price entry and exit points to maximize profits.
When trading range-bound stocks and other instruments, it is also imperative to be wary of potential breakouts. Ranges typically happen during a period of indecision in the market or when a trend is pausing.
Breakouts happen when prices advance strongly outside the defined support and resistance levels and consequently when resuming an old trend or establishing a new one. It is, therefore, important to determine the ideal places to put in place stop losses that will help limit your losses in case a price breakout occurs.
Range Trading Strategies
Here are some technical indicators that will help you verify quality range-bound setups:
Range Trading with Pivot Points
Pivot Points is one of the best indicators for mapping out horizontal support and resistance levels in the market. The standard Pivot Points indicator has a reference line (PP) as well as three support lines (S1, S2, and S3) and three resistance lines (R1, R2, and R3).
In a range-bound market, these lines allow traders to observe support and resistance levels in the market and determine ideal areas to place entry and exit orders. For instance, if the price is trading between R1 and PP, traders can look to buy at or near PP and sell at or near R1. When buying at PP, stop loss can be placed below S1 and take profit at R1. Similarly, when selling at R1, stop loss can be placed above R2 and take profit at PP.
Pivot Points is a solid indicator for trading ranging markets. Still, traders can make it even more effective by combining it with Oscillators, such as RSI, or Candlestick Patterns, such as Pin Bars and Double Tops/Bottoms.
Pivot Points are also excellent for watching out for breakouts. When a strong pivot points line has been breached, traders can adapt to a strategy in tandem with the new market condition.
Range Trading with Volume Indicators
Volume is one of the most essential elements of an asset’s price that range traders watch. The inherent belief for technical analysts is that volume precedes price, and when applying range trading strategies, volume can help traders qualify high probability setups.
In ideal range setups, the volume should decrease when the price is about to hit the support or resistance levels and increase after bouncing from those levels. Volume indicators help assess whether a price movement in the market is backed by conviction.
With range trading, volume indicators can also help watch out for valid price breakouts. If the price breaches the defined support and resistance levels with high volume, then the breakout is valid; but if the levels are broken but with low volume, that is potentially a false breakout, and traders can continue applying range trading strategies.
Some of the best volume indicators to use when trading range-bound markets include On Balance Volume (OBV), Volume Price Trend (VPT), Money Flow Index (MFI), Accumulation/Distribution, and Negative Volume Index (NVI).
Range Trading with Volatility Indicators
Volatility is the frequency and severity of price changes in the market. Generally, ranging markets are characterized by low volatility, with prices making predictable movements off support and resistance levels. Thus, volatility indicators can help qualify markets where range trading strategies can be implemented.
For instance, the Average Directional Index (ADX) can be used as a range-bound market filter. ADX plots values from 0 to 100, with higher values denoting more robust trends. A reading of below 25 confirms a range-bound market.
There are also envelope-type volatility indicators such as Bollinger Bands and Keltner Channel computed to ‘contain’ price. Such indicators will have the price contained within their upper and lower bands, serving as references for support and resistance levels.
Volatility indicators will also ‘notify’ traders when a valid breakout happens in the market. For instance, the ADX will confirm a breakout with a reading above 25, whereas the bands of envelop-type indicators will diverge when high volatility returns to the market.
Pros and Cons of Range Trading
- Straightforward Strategy – Range trading is very straightforward. Ranging markets have stable, predictable price action, and you are required to buy at support and sell at resistance. There are also clear stop loss and take profit placement guidelines.
- Quick Turnaround – There is a quick turnaround time for trades in a ranging market. Prices oscillate between support and resistance levels within a short period. This makes the strategy suitable for short-term traders who do not wish to leave their capital exposed to the market for more extended periods.
- Applicable to all Markets – All markets tend to have periods where prices range. Whether it is forex, stocks, commodities, indices, or cryptocurrencies, range trading strategies can be applied with a sideways trend in the underlying market.
- Limited Profits – Range trading can limit the profits you can make in any single trend. Take profits are placed rather close to the entry price, which results in low yields. Furthermore, because the price moves back and forth in ranging markets, traders are forced to take many trades to maximize profits. But this results in additional trading charges, limiting the bottom line.
- Pinpoint Entries and Exits – Successful range trading requires traders to pinpoint optimal price entry and exit points. Support and resistance areas are usually zones rather than specific price points, and it can be difficult to identify optimal entry and exit prices that offer reasonable risk/reward propositions.
- Breakout Risk – This is the most considerable risk when range trading. Price will never be contained within a range forever- it will eventually break out. Breakouts are generally strong and can lead to severe capital losses for range traders, especially if they do not use stop losses.
Sideways trends are a very common market condition in all financial asset classes. Therefore, it is vital to identify and exploit lucrative opportunities in range-bound markets. Browse through the comprehensive AvaTrade education centre and learn about the best way to identify different market conditions and how to take advantage of opportunities in them effectively. You can open a free trading account when you are ready to test your favourite trading strategies.
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What is Range Trading?
Range trading is a strategy used by traders to take advantage of opportunities in markets with no clearly defined trends.
Which Assets Can I Range Trade?
All markets! Every financial market has periods when prices display sideways price action.
Is Range Trading Easy?
Yes. Range trading is straightforward- you need to buy at support and sell at resistance. However, it would be best if you were wary of price breakouts.
** Disclaimer – While due research has been undertaken to compile the above content, it remains an informational and educational piece only. None of the content provided constitutes any form of investment advice.