Range Trading Explained (Part I)
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. Ranges are periods when the markets move up and down without any clear directional trend. Some would characterize the price action during a range as sideways or horizontal.Know how to read forex charts. First practice on your forex demo account. Learn swing trading.
It is between these support and resistance levels that the range trading opportunities lies. Range trading simply involves identifying and profiting upon the turns within a horizontal trading range.
Range traders do not let their profits run the way the trend traders do. Why it is so? These turns are also considered swings so the techniques of range trading are often an important component of swing trading strategies.
The primary reason is that the upside in range trading is necessarily capped at the other side of the range. It is because of this fact that some traders especially those that trade trends consider it to be much lower probability method.
Range traders can overcome this dilemma and increase their potential upside by setting a minimum threshold in terms of the height of the ranges they are willing to trade. For example, a 20 pip range that forms on the GBP/USD pair during the Asian Session is not really worth range trading.
In simple terms, 20 pips potential profit is not sufficient to justify the risk of range trading. The height of this range is too small to make it worthwhile as a range trading opportunity. However, a 300 pip range can definitely offer an abundance of good potential range trading opportunities.
If the stop losses are always placed just beyond the support or resistance level from which a range is bounded, a profit target on the other side of the range would offer a higher probability trade from a risk/reward perspective. Therefore a prudent range trading criterion should include some minimum height of the range.
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 can be very helpful in trading ranges that do not have strictly defined upper and lower bounds. You can also use the dynamic bands like the Bollinger bands to outline these levels.
But when using the Bollinger bands to define a range 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. Only then you can be confident that a horizontal range is indeed in place.
