The Basics Of Range Trading

Range trading is one technique forex traders can use in an effort to meet their investment objectives. Some traders use this approach in an attempt to identify ranges, predict how a currency or currency pair will behave, and profit from such expectations.

As always, no investment strategy is guaranteed. Certain traders harness ranges to forecast that a currency will remain between certain highs and lows. However, the currency could break out of the range and then return, or it could break out and form a new trend. In either case, making transactions based on the belief a currency will fluctuate between specific highs and lows could produce losses.

In addition, while range trading can prove helpful, it is only one approach. Some traders use this technique when markets are flat, but others turn to alternative strategies such as covered calls. Any forex trading strategy will come with its own unique risks and considerations, so investors are encouraged to do their homework and/or consult an independent financial consultant before deciding upon using any particular approach.

Range Trading For Beginners

Many capital markets, including forex markets, exhibit price ranges. More simply put, asset values sometimes fluctuate within specific limits, which are created by support and resistance. They then serve as the floor and ceiling, or the periodic high and low price.

For a brief refresher on support, it is a price that a currency will probably not fall below. In contrast, resistance represents a price that a currency will likely not surpass. Using technical analysis, some investors seek to identify the ranges created by these levels, which appear when markets are unable to push a currency beyond a specific high or low.

Armed with this information, some traders attempt to profit from the range by setting up certain trades. However, it is important to keep in mind that in many cases, securities will only fluctuate between specific highs and lows for so long. After a period of time, they make a hasty exit and establish a new trading range.

In other cases, these securities might display rather strong trends, moving upward and gaining value over a long period or alternatively trending lower for some time. For example, if a currency is in a bull market, a trader might be able to take advantage of this general upward trend. However, market conditions such as this may not provide the best backdrop for range trading.

If you believe a currency will fluctuate between specific highs and lows, you can take three specific steps to set up a range-trading strategy: identify the range, set up entry and define your risk management parameters.

1. Identify The Range

First, you need to identify the trading range. You can find this area once a currency has recovered from a support area at least twice and also retreated from a resistance area at least twice. These highs and lows do not have to be identical, but they should be close together.

To define the extremes of a trading range, draw a simple trendline through the periodic highs and lows. Once again, each line doesn't have to be exact; they are broad representations of where potential support and resistance levels may lay. These lines are going to have a zero slope to define the right-to-left price moves.

Some traders hold out for more than two highs and two lows, waiting until a currency hits both support and resistance at least three times before declaring a range exists. Generally, the longer a price movement is constrained between a resistance and support level, the stronger the trading range.

Once the highs and lows have been pinpointed, they can be connected with horizontal lines. The area between these lines represents the currency's trading range. This process may be repeated on any forex pair on any timeframe.

2. Set Up Your Entry

After identifying the range, you can set up buy orders near support and sell orders close to resistance. Some traders use indicators—for example, oscillators such as the relative strength index and commodity channel index—to help them place trades. Others rely on a moving average or a Fibonacci retracement to define market entry.

By using these indicators, investors may be able to determine when a currency is close to support or resistance. In addition, they might obtain a better sense of when to enter or exit positions. Insights into when to enter or exit the market are invaluable during periods of volatility. Any day trader will attest to this point, as it is one of the keys to protecting capital in chaotic markets.

Depending on the amount of time you have available to make these transactions, limit orders or market orders may be more appropriate. For instance, when day trading, limit orders may be ideal because of the shorter time frames and compressed trade durations. On the other hand, swing traders can use market orders because they trade on a multi-session basis.

If your time is limited, entry orders may make more sense, as they will remain open only until the currency hits the specified price. However, if you have greater flexibility, it may be wise to use additional technical indicators to confirm support and resistance before executing market orders.

3. Manage Risk

Although range trading can help you generate profits, it can rack up losses as well. For example, you could incur losses if you set up some orders within a predetermined range and then the currency in question breaks past resistance or falls below support. Given this scenario, a significant loss could be realised if proper risk management tools aren't implemented. To eliminate the chances of experiencing extraordinary loss, simply place a stop-loss order above sells and below buys.

This undesirable outcome could happen whether you encounter a false breakout (meaning a currency moves outside the range and then retreats to within this predefined area) or has an actual breakout (where a new upward or downward trend is established). In either case, the anticipated pullback in price didn't occur; the result was a loss or drawdown. Although using a stop-loss order can lead to unexpected losses, it does protect you from falling victim to a breakout.

It is also worth noting that when trading ranges appear, they can easily attract the interest of many investors, which can result in turbulent price fluctuations and repeated temporary movements either above resistance or below support. This phenomenon is especially common in stock trading, where huge market participation often creates disjointed price action.

Should a currency break out of its range, you can simply exit any range-based positions that have been established. One way to achieve this objective is using stop losses. For example, when selling the resistance zone of a range, some traders will place a stop above the prior high. Alternatively, these investors could set up a stop below the previous low when buying the support zone.

Even though some traders successfully harness stop losses to manage the risks associated with breakouts, certain ranges present little opportunity, as the small gap between resistance and support may not justify the risk and transaction costs associated with setting up trades.

Getting Started With Range Trading

After learning the range trading basics, some investors test their skills by using a practice account. By taking this approach, they can evaluate their strategies without putting their capital at stake. Upon receiving feedback on their respective approaches, they may be in a more informed position to try to meet their investment objectives.

Paper or demo trading isn't a 100% depiction of live market functionality. Although the speed, order entry and price action are the same, the actual trade execution can differ. Factors such as order flow and data latency can lead to undue slippage.

Summary

Range trading is a strategy that requires a trader to define an area where a security's price action has traded for a period of time. This zone is known as the market's "range." Within the range, price is constrained by a topside resistance level and bottom side support level. To execute a range trade, one sells resistance and buys support in anticipation of a pull back in price.

Range trading is a valuable tool in any trader's toolbox. Through targeting range-bound currency pairs, one can capitalise on price action and cash in on sideways markets. By adhering to strong risk management principles and exercising discipline, many range traders are consistently profitable.

As always, risk is inherent to investment, so forex traders can benefit from conducting their due diligence and/or consulting independent financial advisors before participating in range trading or other strategies.