Range trading is one way to trade the currency market when there is no trending movement in the market. There are times that might last for prolonged periods when the markets are not in any major trend and are only moving sideways swinging between two extremes. But first let’s define what these terms mean. So what is a range? Generally a range is a type of price action bounded on the top by a resistance level and on the bottom by a support level. Some would characterize the price action during a range as sideways or horizontal. Ranges are periods when the markets move up and down without any clear directional trend.
So when the market is in a range, the price action is swinging between two almost horizontal lines. Range trading simply involves identifying and profiting upon the turns within the horizontal trading range. It is between these support and resistance levels that the range trading opportunities lies.
In trend trading, once you have identified a trend forming in the market, you try to enter it as early as possible and ride it as long as it lasts to maximize your pips. Range traders do not let their profits run the way the trend traders do. These turns are also considered swings so the techniques of range trading are often an important component of swing trading strategies.
Since a range is usually bound by two extremes, traders especially those that trade trends consider range trading to be much lower profitability method. The primary reason is that the upside in range trading is necessarily capped at the other side of the range. So when you do range trading, you have to be clear that the profit potential in range trading is limited unlike trend trading.
For example, a 20 pip range that forms on the GBP/USD pair during the Asian Session is not really worth range trading. To tell you the truth most of the time, the market is in a consolidation mode or ranging mode. It is only moving sideways. If you are a trader who makes a living from trading than what to do during such times when the market is not trending and only ranging. Of course learn range trading. Range traders can overcome the dilemma of lower profitability and increase their potential upside by setting a minimum threshold in terms of the height of the ranges they are willing to trade.
20 pips potential profit is not sufficient to justify the risk of range trading in simple terms. The height of this range is too small to make it worthwhile as a range trading opportunity. But this may be the best time for scalping. 3-5 pips gain per trade can be easily made in such a range. However, a 300 pip range can definitely offer an abundance of good potential range trading opportunities.
A profit target on the other side of the range would offer a higher probability trade from a risk/reward perspective if the stop losses are always placed just beyond the support or resistance level from which a range is bounded. Therefore a prudent range trading criterion should include some minimum height of the range.
So the important characteristics of a range is being bounded by two horizontal lines on upside as well as the downside. Once the height of the range is established by at least two approximate touches of both the support and the resistance preparation for range trading should begin. Most range traders will use the common horizontal lines on their charts as the support and resistance for the range.
Bollinger bands are used to measure the volatility in the market. The more volatile the market the more apart the two bands will be. Bollinger bands can be very helpful in trading ranges that do not have strictly defined upper and lower bounds. You can use the dynamic bands like the Bollinger bands to outline these levels.
There is always a simple moving average (SMA) that runs through the center of the two Bollinger bands. You should be careful with the slope of the simple moving average (SMA) running through the middle of the band to ensure that it is flat or near flat when using the Bollinger bands to define a range. Only then you can be confident that a horizontal range is indeed in place.
Range trading involves identifying the points when the price action turns and reverses direction between the two horizontal lines. Go short at the resistance level when the buying pressure loses momentum. Go long at the support level when the selling pressure is overcome by the buying pressure. You can simply use common oscillators like the Stochastics or RSI (Relative Strength Indicator) to help identify potential turns at or near support or resistance when you have established a range.
You must have heard the terminology of the stochastic indicator being overbought or oversold. The Stochastic indicator measures the position of the currency pair compared with its most recent trading range. A Stochastic indicator identifies swing, tops and bottoms.
The closing price tends to be closer to the extreme highs of the currency pair as the currency pair price rises. So what does a stochastic indicator does? Specifically a stochastic indicator measures the closing price of the currency price and it’s high or low during a specific number of days or weeks.
The stochastic indicator is considered to be a highly accurate method of picking the tops and bottoms. The Stochastic indicator points our overbought or oversold conditions. Similarly, the closing price tends to fall on average closer and closer to the extreme lows when the price falls.
Now let’s discuss briefly what does the Relative Strength Indicator does? The Relative Strength Indicator (RSI) is designed to indicate the market’s current strength or weakness depending on where the price closes during a given period. The RSI is plotted on a 0-100 scale.
You should know this fact that the buy and sell signal levels will vary depending on the length you choose for the RSI calculation. Try different lengths to figure out what works best. However, a buy signal is usually generated when the RSI moves up through the lower band usually at 30. Similarly a sell signal is usually generated when the RSI moves down through the upper band usually at 70.
Practice with the RSI on your demo account for sometime to become familiar with its use. Most prices seem to change direction at 30 and 70. However, note that this is not a hard and fast rule. A shorter length time frame will result in the RSI being more volatile. A longer length time frame results in a less volatile RSI.
So range trading involves using indicators to generate the buy and sell signals. How do you know when to buy and when to sell in range trading? The most common method of reading these oscillators is to identify the point at which they cross the line exiting overbought or oversold which signals a possible turn in the direction of price action.
It is always good to seek confirmation of a trading signal by using another indicator. Another turn confirmation can be found at the break of an intra range trendline beside oscillators. It is still a valuable confirmation that the turn in the range has indeed occurred although using a trendline break confirmation can result into a late trade entry.
So most of the time the currency market is not trending! Range trading can be an effective method of trading when the forex market is not trending. A tighter stop loss can then be placed on the other side of the trendline break as opposed to the other side of the range support or resistance.
The best is riding the trend as long as it lasts. But as said, most of the time there will be no clear trend in the currency market. The traders can take benefit of the range trading methods during the time the forex market is bouncing back and forth between horizontal resistance and support. Range trading the bounces can be an effective trading method under these non trending market conditions if the established range has sufficient height.
