By their very nature, market players select trading strategies that are in line with their investment horizon, risk appetite, trading objectives, and other factors. Range trading is a perfect example of such a tailored strategy that is the go-to choice by many traders in the market.
There is a lot the range trade approach has to offer to those looking to trade on the basis of a sound and tested strategy. Of all short-term strategies, this stands as being among the most risk-repellant and versatile.
It is also interesting that, unlike other trading approaches, the range trade strategy sees volatility as points of opportunity, rather than risk. For this reason, it is the go-to method for those dealing in dormant prices that are not erratic in nature.
If you want to know more about the fascinating domain of range trading, you’re in luck. In this article, we explore this fascinating trading style that you can incorporate into your own trading strategy, and win big in the intricate world of stocks.
Range trading is a straightforward approach the trader often follows, involving executing trade decisions based on a stock’s price relative to a range of motion. Normally, this range is represented by two horizontal lines which define upper and lower ranges.
At its simplest, the range trade strategy involves buying a security when it is nearest to the bottom of the range, and selling it when it approaches the top. Through this, traders can make multiple gains in a short time.
The optimal time to adopt the range trade strategy is when the market is neither bearish nor bullish but is overwhelmingly static. These conditions allow for reliable ranges to be ascertained, and the strategy to be implemented.
Understanding Trading Ranges
In order to gain a more in-depth understanding of how the range trade approach works, it is important to clarify the role volume and moving averages occupy within this discussion:
For anyone looking to trade within a specified range, it is extremely important to gauge market interest in a particular stock. There is hardly a better measure that conveys this than the present trade volume.
Growing or falling trading volume could impact the ranges of the stock, as the number of buys and sells undertake shifts.
Moreover, ranges are often delicate and can break easily when volume undergoes serious change. For instance, when volume falls to extraordinarily low levels, it is likely that the ranges would not hold on for much longer.
Moving averages are extremely important to range traders, especially because they help determine the mid-levels for the ranges. When the moving average moves, traders can predict the movement of the entire range, and act accordingly.
Often when volume shifts cause uncertainty surrounding trade ranges, the moving average is consulted to gain a clear picture. It helps determine where the range has shifted to with the change in volume.
Risks and Limitations of Range Trading
For those that find appeal in the simplistic nature of the range trade approach, and the prospects for endless gains, it is important to be aware of the risks that come with such a strategy. Some of these are discussed as follows:
With the range trade approach, one of the most common pitfalls is that of false breakouts. This is when a price traverses beyond a range, indicating a range movement, only to immediately fall back within range.
Often, range traders act rashly and adjust their positions following the breakout, only to discover that it was a false signal, and the stock is back within range.
Traders that are solely focused on narrow ranges are effectively limiting their opportunities. They no longer consider rises beyond the range limit as an opportunity of gain.
For example, a stock may take on a tremendous rise but the movement beyond the range could dissuade range traders from partaking in the bullish rise.
Because range trading works best in horizontal movements, it does not truly bank the general upward momentum of the stock market. For this reason, many criticize it for being inefficient.
Its sole gains come from narrow volatility which remains meaningless over a larger period of time.
Stuck in range
There is a chance that range traders find themselves stuck in a range, waiting for a stock to move towards a desired level within the range.
This can seriously limit the particular trader from considering other more promising growth opportunities in the market.
Range Trading Strategies
Within the umbrella of range trading, there are a number of specific strategies that traders follow, based on current circumstances, and their tolerance for risk. Some of the most common are as follows:
Buy low, sell high
This is one of the simplest range trading strategies used in the market, where traders buy a particular stock when it is at the low point of a range, and sell after its climb to the high.
Moving averages are typically used within this approach, and it is a relatively low-risk form of trading in the market.
Another popular range trading strategy is that of oscillating trades. This involves traders using the relative strength index to identify whether a stock is overbought or oversold, with respect to the trading range.
Based on this information, traders enter or exit positions in order to maximize their gains earned.
Mean reversion strategy
This strategy rests on the assumption that a stock price normally reverts to its mean point within the range. For this reason, the price being above the mean is always a sell signal, whereas below the mean is a buy.
Traders often consult simple moving averages to determine which level the mid-point of the range currently lies at.
Ranges and Volatility
It is important to note that there is an intricate relationship between trading ranges and volatility. Ranges cannot be formed in cases of high volatility, as delineating high and low limits would be impractical in such cases.
When volatility is low, stock prices are usually stable, and ranges can easily be identified. In cases of high volatility, prices can swing wildly, which completely breaks down the notion of a static trade range.
It is important to note that, the volatility situation can often change abruptly, so traders must be ready to adjust their positions accordingly. It is always best to have a contingency plan in the case of erratic stock behavior.
Trading Range Strategies
When looking into Trading Range Strategies, breakouts, and breakdowns are the most fundamental indicators that signal to traders shifts in price trends and are thus calls to action.
A breakout occurs when a range trading stock transgresses beyond its range and climbs above the upper range limit. Traders follow the signal by buying because it indicates a strong trend in the upward direction.
Alternatively, the breakdown is also a transgression away from the price range but reflects a fall below the lower range limit. This is a strong sell signal, as it points to an oncoming freefall in price, which attracts short-sellers in droves.
Example of a Trading Range
In order to assess the trade range concept in a real-world context, we turn to take a look at the New York-based investment management company, Alliance Bernstein (NYSE: AB). Shown below is its stock price movement over a single day:
As can be seen in the price trend above, there is a clear range, depicted by the horizontal purple lines that had been maintained for most of the day. AB had mostly been trading within the range, and not deviating beyond it.
While within the range, range traders clearly followed the expected approach of buying at lows and selling at highs.
However, as can be seen, towards the end of the trading session, a clear breakdown occurred when AB’s price fell below the range, and began a downward spiral, taking the stock down to a low point for the day.
Range trading is a popular approach to trading that involves identifying the floor and ceiling within which a stock price oscillates, and using the knowledge of this range to one’s benefit through buying and selling.
Part of the strong appeal of the range trade strategy lies in its sheer simplicity, making it an accessible tool even for beginners in stock trading. The idea of buying at lows and selling at highs clearly resonates with most market players.
It is important to note that range trade strategies come with some limitations that a trader must be aware of before embarking on such a route. Also that the tool is best for cases of low volatility, and horizontal trends.
When applied correctly, range trading can allow traders to make continuous profits by simply buying and selling with the right signals. It is a great beginning approach to take on one’s stock trading journey!
How is range trading affected by market movement?
Range trading is based entirely on how the market moves, and depends on sideway trends. During periods of high volatility, the range strategy cannot be practically implemented and could lead to breakouts and breakdowns.
How might a range trade be set up?
A range trade can be set up by identifying price floors and ceilings during a short or long-term time period. After these have been determined, the price would be monitored in relation to the range; bought at lows and sold at highs.
How are support and resistance used in range trading?
Support and resistance levels are used extensively in range trades, and essentially act as the upper and lower levels of the range. They are monitored in relation to simple moving averages and other technical indicators.