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Don't Get Stuck In A Rut When Trading Ranges

Nov 28 • Forex Trading Articles • 3780 Views • 1 Comment on Don't Get Stuck In A Rut When Trading Ranges

The perceived wisdom within our forex trading community, is that markets range 70-80% of time. It’s therefore essential that FX traders easily identify ranging markets and learn to either take advantage of this phenomena or (if a swing/trend trader) avoid these conditions and costly mistakes resulting in giving back to the market in periods of price consolidation.

When price is trending it can be straight forward to identify, when price is ranging there’s an absence of discernible patterns, price may be oscillating, it may be breaking through the daily pivot, but fails to break the resistance or support levels. In a ranging market the chart pattern can often take on a distorted appearance, if the chart appears random then that could be evidence of a ranging market.

One method to trade these conditions could be to look for overbought or oversold conditions; if price is not breaking resistance or breaking support then it’s reasonable to presume that price may move back and forth from these levels. One method to trade using these conditions is to go short when overbought and go long if oversold. These oversold and overbought limits will most likely be the points where the price appears to ‘bounce off’. Many range traders will look for break out conditions to occur after witnessing this situation.

Know your trading environment. The trading environment is the action around a currency pair’s price movement, you should know how the currency pairs are moving before you enter a trade, price movement of a currency pair provides clues and information that can help you determine the trading environment.

Range-Bound Trading Conditions
In a range-bound trading environment, the currency pair stays within a tight trading zone. The highs and lows of the currency pair’s price moves within fairly constant and distinct parameters. The currency pair remains within these parameters and often bounces off the ‘walls’ of the range. Many traders find range-bound trading difficult and frustrating as there is no definable trend to assist anticipating the price movement.

‘Chartists’ can often determine if a currency pair trades within a range by looking at the chart. The visual information and interpretation requires the eye of an experienced trader to obtain accurate and consistent results. However, there are other often more reliable ways to determine if a currency pair is trading within a range. There are three main range-bound trading indicators/signals.

A Low ADX Level
The ADX (average directional index) measures the strength of a trend. ADX is one of the primary indicators used to determine the strength of a trend. When a currency pair is trading within a range, the ADX level will decline. Conversely, when a currency pair is trending, the ADX level will rise. An ADX level below 20 is considered low. It is a strong indicator of a currency trading within a range. When the ADX is at 25, the strength of a trend is growing, but still may not be strong enough yet to break out of the range.

Decreasing Volatility
Volatility refers to the price movement of a currency pair. When volatility is high, currency prices are moving (or trending) strongly. When volatility is low, prices are staying with a tight range.

Bollinger Bands
Bollinger Bands are an excellent indicator of volatility and price movement. A range-bound currency is indicated when the Bollinger Bands grow together, the bands begin to ‘squeeze’ the currency pair. Bollinger Bands are a superb visual tool for determining volatility within a particular trading environment. When range-bound trading, looking for Bollinger Bands that are close and tight, leaving only a narrow tunnel in which the currency pair can move is considered good trading form.

The trading environment is trending when the currency pair is moving in a strong direction. In a trending environment, the currency pair is moving decisively in a particular direction, up or down. A sideways trend is more indicative of a range-bound trading environment. A trend can be visually identified on a chart, other tools are available that can help the trader to identify a trend.

The length of a trend is quite a contentious subject, it could be considered long-term when it continues for a year plus, short-term trends can last weeks or months. A medium-term trend is the time between a month and a year. Most traders will focus short-term trends for quick trades, but will look for confirmation from the long-term trend.

Long and short-term trends can move in opposite directions, a currency pair may move in a bullish trend for a month or so (long-term trend) and, during that year, experience several day’s-long bearish price movements (short-term trends). Two trending trading signals that are excellent for trend identification are the ADX and momentum indicators.

 

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High ADX Level (25+)
ADX is the average directional index, measuring the strength of a trend. If the number is below 20 the trend can be considered weak indicating that the currency pair is range-bound. A trending environment will usually have an ADX level that is above 25 and continuing to rise.

Momentum Indicators For Trend Confirmation
Momentum indicators gauge momentum. Examples of momentum indicators are RSI (relative strength index), Stochastics, and moving average converging divergence (or MACD) line, visually reviewing charts is also a method to establish the trend, its strength, and its momentum.

Combining both the ADX and the momentum indicators can prove to be an extremely effective method of identifying trending ranging market conditions.

Suggested Combination Of Trading Tools For Range Trading
ADX:
Determine if it is a high number (trending) or a low number (range-bound).
Bollinger Bands: Determine if they are flaring (trending) or tight (range-bound).
RSI: Determine if it is a rising number (trending) or a declining number (range-bound).
MACD: Determine if the line is rising (trending) or declining (range-bound).

Range traders often use patterns on price charts together with technical indicators. Typically range traders identify support indicating where supply has been exhausted, therefore price needs to rise to attract sellers. Looking for resistance levels, price needs to drop in order to attract buying interest. This situation can create a range that occurs between two parallel horizontal lines, a range trader can take advantage of support and resistance levels whilst also looking to profit from range breakouts.

Trading Within the Range
Often currencies will trade within the two parallel lines of support and resistance for days before a breakout occurs. Range traders often have short positions at the top of the range, and take long positions towards the bottom of the range. The stop-losses are generally kept above and below the support and resistance levels, limiting risk whilst ensuring that losses are minimised in the event of a breakout.

Trading Range Breakouts
A trading range will eventually breakout when market forces ultimately overcome either the resistance levels at the upper end of the trading range or the support levels at the lower end of the range. Once the rate moves through either of these support or resistance levels, a price target for a subsequent move sets up that is equal to the vertical distance between the lines that are projected from the price level the breakout originated from. If the breakout occurs to the upside, you add the measured move onto the breakout rate to get the target. Some traders take advantage of such opportunities by:

  • Buy the dip, price often retests the range top after the upside breakout
  • Place a sell stop safely back within the trading range
  • Place a take profit order to sell just below the measured move objective rate

Alternatively, if the breakout occurs to the downside, this sets up a short trade. Traders might then subtract the measured move from the breakout to obtain the target. Then they might wait to sell into a rally to retest the range bottom, putting their buy stops above the range bottom and looking to take profits by placing a buy order near the breakout target.

If managed correctly then range trading and trading range breakouts can prove to be very effective strategies. A level of expertise in relation to technical analysis helps determine the optimum levels for trading. Discipline and patience is an essential requirement for range trading techniques to work successfully over time.

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