How to make the best of a situation where markets are ranging
What if the market lacks a trader's main friend, a trend? When the price is moving sideways, trend trading strategies won't do you any good. At the same time, that doesn't mean that you should twiddle your thumbs. The solution is to use special strategies that give you an edge in range trading.
First of all, it's important to understand the logic of a range bound market. It's actually quite simple: neither bulls nor bears are able to move the market in their favor by much, so the price consolidates.
The period of consolidation may occur after a trend move. In this case, it will be related to profit taking. At the same time, the price may start fluctuating in a wider range due to fundamental, i.e. economic reasons. This can happen when the future is particularly uncertain and market players see contrasting scenarios, both of which are quite probable, so traders are reluctant to make longer-term bets.
As a result, the price settles down within a horizontal range. A range trader bets that it will remain there for some time. The process of range trading may be broken into several steps.
Step 1. Locate the borders of the range, i.e. the levels of support and resistance that prevent the price from going lower or higher. The previous highs of the price chart should be located in the same area. You should also be able to say the same thing about the preceding lows. Notice that as the market is not perfect, we are talking about areas here.
In other words, don't expect all highs to be right at
the same horizontal level. The most important thing is that the market
shouldn't make higher highs and lows or lower highs and lows because these are
the distinguishing features of an uptrend or a downtrend respectively. You can
also use the help of Bollinger bands: this indicator provides dynamic support
and resistance corridor for the price.
Step 2. The obvious logic of trend trading is that you sell when the price is at the top of the range and buy when it's near the bottom. That's necessary, but not enough for making good entries. To increase the probability of success, use oscillators. Technical indicators of this type show whether the asset in question is overbought or oversold.
If the price is near resistance and the indicator sends an "overbought" signal, it's time to think about a sell trade. When the price is at support and the indicator says that the market is "oversold", consider a buy trade. Among the indicators of this sort, we like the Stochastic Oscillator the most as it's visually clearer and easier to interpret.
If you spot a reversal candlestick pattern near the borders of the range, consider yourself lucky: the odds of successful range trade will become higher. A failed attempt to break out of the range is also a sign that the price will likely move to the middle/opposite border of the range.
Step 3. At this point, you can make your
trade. Don't forget about proper risk management. The natural place for a Take
Profit is the opposite border of the range. We also recommend putting a TP not
exactly at it but several pips closer to your entry point. This way the
probability that the price reaches your target will be greater. The Stop Loss
may equal to about half of the range size or less.
Finally, we should mention that it's better to avoid range trading when volatility is high. Think carefully if you see important releases in the economic calendar as they can lead to a break out of a range. In addition, remember that the knowledge of fundamentals will increase your chances of getting profit, so check economic articles to see what's happening at the market and why the price isn't trending.
This article was submitted by FBS.
