Range Trading Strategies

What is range trading? Most people on the street would understand when you talk about trend trading, or even trading against the trend, but range trading needs a little more explanation.

If you’re familiar with trading charts, you will have seen that prices tend to trend up or down about half the time. But there are times, experts say about 40% of the time, when the price seems to move up and down in a close price band, keeping at around the same level. Really it’s the result of the market participants thinking that the price is about right, with no strong push to raise it up or to lower it.

If you look closely, you will see that sometimes the price does seem to meander, and usually this is accompanied by a very low trading volume, basically a sign of a lack of interest in the product. Other times, the price tends to zigzag up and down between two levels, but never achieving enough momentum to break through them and form an uptrend or a downtrend.

This is a classic example of the price trading in a range, and if you know how to play it you can trade effectively, successively picking up small gains on both the up and the down movements.

The key to understanding this type of price movement is a theory of support and resistance. Support and resistance are familiar concepts to a trader. Support is a price level that the price never seems to fall below, and resistance is a price level that the price seems unable to exceed.

There are detailed ways to explain this phenomenon, and it is caused by the psychology of the market participants. It is well-established and can be relied upon to a reasonable extent. Of course, at some time the price will go through a support or resistance level, but generally once the price is in a trading range it may stay in that range for a long time.

So when putting together a strategy, we start with the assumption that the price will fluctuate, always keeping above support and below resistance, until such time as it ‘breaks out’.

This makes the strategy easy in concept. The key is to find a stock or financial product that is range trading within well-defined support and resistance levels. When it reaches down to support, you go long, expecting it to bounce upwards; when it gets up to resistance, you close the long position and, optionally, can open a short bet to profit when the price falls.

Even the best of range trading opportunities will come to an end, so it is important to have a strategy that includes closing your bet if the price goes too far outside the range, i.e. if the range trading has broken down and the price has started trending.

Some experts suggest closing the bet if the daily price closes outside the range for a day or more. You also need to close the bet if the price goes too far outside the range, so it would not be reasonable to expect it to come back and carry on range trading.

Now, even though the way support and resistance work they seem to have an uncanny ability to deflect the price movement, there will be some fluctuation in what actual price is the lowest or highest at any particular turning point. The strategy therefore has to have some leeway to allow for incidental fluctuations.

When looking for support and resistance levels, it is important to look back on longer-range price charts. These can give you a better understanding of how solid the current levels are – the more times the price has touched a level and been rebuffed, the more likely it is to continue respecting that level.

So in summary the range trading strategy is to identify visually a stock or price that is staying within a range, and then look at more detailed charts to determine where the support and resistance levels are. At this stage, you need to assess how wide a range is available, and compare this with the trading spread offered by your dealer, to make sure that the reward is worth the effort.

That said, you take a long position when the price is near to support, and place a stop order just below the support, in case the price breaks out downwards. You have to enter the trade when the price is near to support, as it might never quite touch it, and you would end up not trading on the rebound.

Similarly, when the price approaches resistance you need to take a view, and exit the trade to capture your profit. Optionally, you can then switch to a short position, with a stoploss just above the resistance, so that you can profit from the price falling.

The gains you get with range trading tend to be smaller than when trading on a trend, but as you can repeat them over and over again, it can still be worth considering this strategy.

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