Lessons from the Pros

Forex

Dealing with Trading Ranges in Forex

I have often heard that it is easier to analyze and speculate in financial markets which trend. Many may have even heard of the saying the trend is your friend. In the case of an uptrend, traders would focus on buying. When price is showing the pattern of a downwards trend, it makes sense to look for shorting opportunities.

I’ll admit, when a market is trending hard it does tend to make sense to play the probabilities in your favor and go with the flow, rather than against it. However, in the world of Forex trading and speculation, currency pairings don’t tend to trend quite as much as we would like. Typically, the longer trends can be found in global equities markets and specific commodities as well. The currency market will tend to go through longer periods of ranging activity from time to time and FX traders should be prepared to deal with this accordingly.

The Dynamics of a Currency Pairs on Price

The nature of currency markets is that we always trade FX in pairings, putting one currency against another. Just this dynamic alone makes it practically impossible for any major pair to go to zero anytime soon. In a worst case scenario, a pair could have a price quote of zero hypothetically, but that would mean one would have to go to zero against the other which is unlikely to ever happen given that most worldwide economies are part of a larger global picture which impacts them all in similar ways.

That said, this does not mean that individual economic factors can’t have big repercussions for nations and the currency. Just remember how the Brexit vote in the summer of 2016 hit the British Pound for a devaluation on over 20%, practically overnight. Yet here we are more than 3 years later, and the pound has rallied from those previous lows with a slight recovery. In the longer term, say a year to a decade, we are more likely to see general ranging in the FX market, more so than other assets classes, simply due to the nature of there being 2 currencies in all pairings.

Scale is another key factor in explaining why trends take longer to develop in the Forex market, resulting in more ranging periods. This is because the fundamentals behind currency pricing is on a much larger scale than that of an individual stock. Moves tend to take longer to develop because we are dealing with a far bigger economic picture with global currency. The FX market itself is by far the largest market in the world with over $4 trillion of turnover potential a day, compared to the US Stock Market at around $25 billion a day. With all of this in mind, it makes sense for FX traders to have tactics for both trending and ranging markets.

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Strategies for Trading Range Bound Markets in FX

One of the many advantages of the Online Trading Academy Core Strategy is its versatility for all market conditions. When you take price behavior back to its basics, Supply and Demand will always be the key forces which drive prices in either direction. The more we can recognize and use this understanding in trading, the cleaner and simpler it will be to find opportunities.

I have always been someone to follow the actions of the larger banks and institutions because they create the biggest moves in the markets. They have the money, the position size and the influence to push prices up or down with their buy and sell orders, something the retail traders will be unlikely to ever do. Their footprints should help us to determine their actions, which in turn can give us a simple approach when deciding whether to buy, sell or do nothing in the markets.

A great example of the impact of the big market players can be found when we look at the price activity of the USDCAD pair since the spring of this year, as seen in the chart below:

Forex chart of the USDCAD pair

The pair has been moving plenty, but in both directions. There have been some trending periods, however they have been short-lived. This suggests that the major market influencers are indecisive about the fair value of USDCAD. Trying to follow a long-term trend in this pairing would have been very frustrating for anyone. Yet if we look to the extremes, we can see some very powerful examples of institutional buying and selling activity which created major Supply and Demand zones of opportunity. I have highlighted several for you in the next example below:

Supply and demand zones on a chart of the USDCAD FX pair

Doesn’t this chart take on a whole new picture now? Notice how from Supply A and Demand A we have powerful moves away from the consolation patterns marked in yellow. Clearly, in these areas we had major imbalances between the buyers and sellers resulting in the moves upwards from demand and down from supply. Who do you think has enough money and large enough order size to potentially create moves of this size? Likely it was institutions, not retail traders. With these areas creating the extremes of price action, we can then see how, when both areas were retested at later dates, the price failed at both points and reverted to its mean.

The danger we run into when price is ranging is being too eager to jump in before the price reaches its extremities. Supply B worked well as it is on the higher end of the range and still offered a decent potential profit, yet Demand B is, for me, too much in the middle of the range with less potential upside for a profit margin. While we could still get a decent reaction from this demand zone, it would make more sense to play on the side of caution and wait for a lower entry.

When trading ranges in Forex you must adopt the patience game as it is very easy to get outsmarted by indecisive price movements. The rules are simple: it is generally best to avoid the middle and stick to the extremes! I hope you found this of help.

Be well and take care,
Sam Evans – sevans@tradingacademy.com


DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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