A range-bound market is as a trading strategy that identifies stocks trading in channels. With technical analysis, trader finds major support and resistance levels and buys stocks at the lower level of support (bottom of the channel) and sells them near resistance (top of the channel). In simple terms, the highest point within the price consolidation is considered a resistance area. And the lower price within the range is treated as support area. The high price is the major resistance level in which price can’t seem to break through. Likewise, the low price is the major support level in which price can’t seem to break as well.
A range bound trading strategy is based on the tendency of prices to return back to their average price after a particular period of time. This theory has been implemented in various trading strategies over decades and involves the purchase or sale of stocks, currencies and other assets. This strategy is based on the relation between current prices and average prices.
Effective Strategies for Trading Range-Bound Securities
It is essential to first confirm the range to trade range-bound security effectively. This means the price should have reached at least two similar highs and lows without breaking above or below at any point in between. Once we conform the range, or price channel, the trading strategy is simply to buy near the support level and sell near resistance level. The idea is that the price is more likely to rebound from these levels than break through them, which puts the risk-to-reward ratio in their favour.
But this approach is not risk-free due to certain factors. These factors include fundamentals and speculative forces. These are responsible for pushing the price either above or below its historical average. And the price can remain out of line with its average price for an extended period before eventually returning to its average. It’s very important to always watch for a potential breakout or breakdown. Most traders place stop-loss points just above the upper and lower trend lines. This is done to mitigate the risk of heavy losses from a high volume breakout or breakdown.
The advantages of trading in a Range Bound market
- The Range has clearly stated levels. When you have a range on the chart, you’ve got a clearly stated high and low of a horizontal channel. This means you recognize when to expect a possible price bounce within the other way.
- You can get in early on a Trend when the price breaks beyond the range. When a significant breakout occurs out of a range, you will seek an extension of the price move. Trading the initial breakout offers a really desirable Reward to Risk ratio. And results in quite profitable when the breakout extends into a period of time.
The disadvantages of trading in a Range Bound market
- When the Forex pair is ranging, we have no trend, which might be traded, and that we may experience false breakouts and whipsawing price action.
- Also, the price action is followed with low trading volumes which makes gauging market direction more difficult.