What is a trading range in the market?
Financial markets spend a considerable amount of time going back and forth within a relatively defined price area. This is known as a range. In fact, most trading products spend about 70% of the trading hours within a range. While trading trends and joining them is easy and straightforward when they are established, most traders miss the obvious and other market structure that dominates trading. In this article, we will dig deeper into the dynamics of ranges, how to trade them and what to do when a breakout occurs.
How to trade the range?
Let’s look at the steps needed to properly trade a range now that we know its true definition.
Identifying the range
When we notice that a certain market is bouncing between two specific areas, and have done so multiple times, we know that this specific market, and on this timeframe, is currently ranging. In other words, a ranging market will look like a zigzag or a seesaw, with prices going back and forth between two areas.
Let’s take a look at the following two markets (Figure 1 and Figure 2) where one represents regular trading conditions and the other shows a clear range:
In Figure 2, you can clearly see how the market is basically going back and forth in a specific area, bounded by two fairly defined price zones. While it is not an exact range, the market spent nearly 1 month stuck between two price areas. One interesting thing to keep in mind is that ranging conditions can prevail for quite some time but after a few weeks, a large move becomes a very big possibility.
It may seem obvious to just enter a buy trade when the price reaches the bottom part of the range or a sell trade when the price reaches the top part but that may not be the best and most optimal approach at trading the range. Ideally, when the price reaches one extreme of the range, there are different factors we can look at that would help give us an optimal entry, and one that could minimize our risk greatly.
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.
Another approach would be to look for overall strength or weakness in the way the candlesticks are being formed. For example, let’s assume the price is moving lower and is near the lower boundaries of the range. The past few candles have shown many tails with prices consistently closing near the highs of each candle or somewhere in the middle. This tells traders that the market is finding demand near those prices and struggling to close lower. In other words, there’s no more steam and the price is likely to reverse from here. Here’s an example (Figure 4) showing overall strength coming in following extended downside.
For the possibility of more specific entries, you can use a smaller timeframe and look for reversals closer to the support and resistance areas of the range. Such an approach, which requires experience and is more geared for advanced traders, can help you find better pricing while lowering your risk and maximizing your reward. Ideally, you want to look at a chart that is 4 times less than your original timeframe. For example, if you are using the 1-hour chart, you can look at a 15-minute chart for better entries. Alternatively, if you are using the daily chart, you can look at a 6-hour chart but given that most platforms do not support them, you can use a 4-hour chart or the slightly less common 8-hour chart.
Exiting a range trading position is usually done by targeting the other side of the range. Nonetheless, it’s important to keep in mind that the action from one extreme to the other may not be smooth and could create anxiety for traders. One way to tackle this is by exiting part of the position around the midpoint of the range. For example, if you are long 100,000 EUR/USD, you can exit 50,000 around halfway and move your stop loss to the original entry price, securing the rest of the position from any sudden reversals.
Another approach would be to move your stop loss to your entry price as soon as the position is in profit by a set number of pips. Keep in mind that the market does whipsaw and could take out your stop if it’s too close to the market.
Indicators are a great addition to any trader’s arsenal of tools and can be exceptionally useful if the market is ranging. Since most indicators have a fixed range, they work better during ranging conditions.
Let’s take a look at how we can use some of the most common indicators out there, to our advantage when trading ranges. Below, we will discuss the CCI indicator but RSI is also another great example of an indicator that could help confirm signals during ranging conditions.
The CCI is an oscillator that was developed by Donald Lambert in 1980. Originally, it was meant to be used to analyze commodities but has grown in popularity since then and is now applied across all financial markets. The indicator usually oscillates within a range of 100 and -100 with 0 acting as a momentum trigger and 200 as well as -200 considered as extremes or points of reversal.
There are several ways that the CCI can be used for range trading. The first one focuses on signals when the CCI reaches 200 or -200. In this case, we know the price is overextended and a signal from here makes sense. Here’s an example (Figure 5) of CCI coming back from an extreme level and giving a sell signal in a ranging market.
Another way of using CCI would be to wait for a move above 100, preferably above 150 or 200, and then a cross back below 100 for a short trade. Alternatively, traders would wait for a dip below -100 and preferably -150 or -200 before a reversal and a cross above -100 for a potential long trade.
It’s important to keep the context in mind and find weaknesses or strengths in price action itself instead of just relying on CCI or any other indicator as they can give many false signals.
Putting it together
Eventually ranging conditions end. If you are on a smaller timeframe, this could be a few hours or a few days. Bigger timeframes can see price action consolidating for days and weeks, maybe even months. Remember that ranging conditions on a daily chart could mean strong trends on a smaller timeframe. Trade them knowing that your latest trade may fail because the range could end. You might make a few profitable trades here and there but always keep your stop losses intact and your eyes on the market to know when the range is coming to an end.