Introduction
Out of the thousands of trading products available throughout the world, one characteristic brings them all together: They are either trending up or down, or ranging within two rough areas. Some traders prefer joining the trend and riding it while others look for consolidating price action to try and trade a recurring cycle of swings. In the following article, we will examine what a trend is versus a trading range, how to identify the current price action of a specific market, which timeframe to use, and what is the best approach to trading those two market conditions.
What is a trend?
Have you ever looked at a chart and saw a market moving higher consistently with minimal breaks? Maybe you follow up on the price of Gold and noticed that day after day, the yellow metal Is notching higher gradually. A trend is a directional move in a specific product with minimal breaks or corrections. In other words, imagine a trading product that is moving 1% higher every day and has done so for the past 2 months. In this case, that product is said to be in an uptrend (figure 1). Visually speaking, an uptrend looks like a set of stairs that you can climb, which each step being higher than the previous one. This is also the case for downtrends but with lower prices over time.
When the price is at one extreme, we can look for candlestick patterns to confirm the potential reversal. For example, Let’s look at the chart below (Figure 3) where we can see that price is at the top of the range and has formed a reversal candlestick pattern. In this specific case, it’s a shooting star pattern, indicating weakness and a failure by buyers to push prices further up. The candlestick pattern gives us extra confidence in taking the trade and tells us that the market is ready to move lower based on common technical analysis applications.
From a technical analysis perspective, an uptrend is a series of higher highs, and higher lows while a downtrend represents lower highs, and lower lows.
Do trends go on forever? Never, yet it’s very hard to anticipate how long a trend can continue for.
Figure 1 – hourly EURUSD chart showing a downtrend
What is a trading range?
A trading range (figure 2) is a type of market that shows price stuck between two price areas. In this case, price fails to break resistance or support, over and over again, and can stay within the same zone for a while, swinging higher and lower, until something meaningful happens to bring it out of its r
Trading ranges are common occurrences and can even happen within trends when looking at different timeframes. They can also be a sign of distribution or accumulation of positions as well as anticipation ahead of a very big event that is likely to be a market mover.
Figure 2 – hourly USDJPY chart showing ranging conditions
Identifying market conditions
While identifying trends is fairly straightforward, establishing that a certain period is a trading range is a bit trickier. Let’s focus on that. The easiest way to identify a trading range is to find a support and resistance area that have been tested at least once. The following example (figure 3) can give a better overview of the initial stages of a trading range:
In this example, you can see the GBPJPY pair moving lower and then correcting higher, forming a support area then a resistance zone. The next few hours (figure 4) will show you that the market remained stuck in that same range, until eventually breaking lower. While trading the range was profitable if traders bought near support and sold near resistance, the final trade would have resulted in a loss and that’s expected given that the range came to an end with a break to the downside.
It’s worth mentioning that ranges are not perfect and while it’s easy to establish support and resistance zones, the market may not always respect them to the point and can overshoot or undershoot them, depending on different factors such as volume and momentum.
Figure 3 – 15 minute GBPJPY chart
Figure 4 – 15 minute GBPJPY chart part 2
Structure within structure
As we have previously mentioned, trends will occasionally feature corrections. If we are looking at an uptrend, after some upside, the price may look to correct lower. Sometimes, this correction will be strictly downwards while other times, it may move down a bit and then settle into a trading range. This is referred to as structure within a structure. In other words, trends can include consolidating periods or ranging conditions. At the same time, ranging conditions can see minor trends on each leg of the swing between the established range.
Take a look at the example (figure 5) below:
What we are seeing here is a clear uptrend that has been in place since the beginning of the year. The green rectangle highlights a period of consolidation and when zoomed in to a smaller timeframe (figure 6), it can show how price was range bound for some time before the break higher took place. Learning to trade ranges would have allowed you to benefit from the price action during that period of time or at least anticipate when the breakout is occurring so that you can join on the next correction of the trend.
Figure 5 – Daily USDJPY chart
Figure 6 – 4 hour USDJPY chart
Which timeframe should I use?
The timeframe you trade is purely a matter of choice and preference. Some traders prefer a short timeframe where moves are smaller but the action is quicker and opportunities are more often. Others may enjoy a longer timeframe where the ranges are bigger and can take hours and even days to manifest themselves.
It’s worth noting that even though you may choose a bigger timeframe, it’s important to consider a smaller one when looking to enter. It can help you gain better accuracy and could allow you to reduce your risk by being more specific and finding optimal conditions. You can even go as far as having a third layer of a smaller timeframe where you seek even greater accuracy. Nonetheless, too much of it can lead to losses due to noise and traders end up missing on the entire move.
To give clearer examples, if you feel you are comfortable trading ranges on a 4-hour chart and are okay with waiting longer periods of time for an opportunity, you should consider looking at a 1 hour or a 30 min chart for a more exact entry when price has reached one end of the range.
If you prefer looking at ranges on a 30-minute chart, your next timeframe should be a 5 or 10 min chart for entry purposes.
How to trade Trends
Trading trends, especially established ones, is easier than you think with a bit of analysis and common sense. Basically, you need to join this trend at an optimal time, entering when the market is correcting shortly in the opposite direction of the main trend. By doing so, you are able to limit your risk and maximize your reward especially in the vent that the trend does reverse or the market suddenly corrects sharper than what was originally anticipated.
We will look at more details on trading trends in our future articles.
How to trade Ranges
Ranges are fairly straightforward with the idea of buying when price is at the lower end and selling when price as at the top of the range. While this could present several profitable opportunities within a single range, it’s worth noting that ranges can end at any moment and you should always have a stop loss to any position if the market suddenly breaks out to the upside or downside. Given that the market is ranging nearly 70% of the time, it would be wise to learn how to trade ranges especially with the multi-timeframe approach which could provide better accuracy and lower risk.
Our upcoming articles will address how to trade ranges and which tools to use for better entries and improved risk to reward ratios.
Putting it together
Understanding market structure is just one piece of the puzzle but an important one nonetheless. Understand how the market works and keep in mind that the market ranges most of the time. Try to identify what your market of choice is currently doing. If it’s trending, look to enter on corrections. If it’s ranging, trade the range with multiple timeframes and wait for the breakout to join the trend. Occasionally, a correction may turn to a range and with proper knowledge, you should be able to adapt your trading style based on the current market structure. Remember, price is always leading and whatever it is doing or has been doing is what you should be focused on.
You will not always get it right or be on the correct side of the market so make sure you use stop losses to protect yourself against excessive volatility and unusual market conditions which could lead to misleading and unprofitable structures.