Over the last couple of months the Stock Index futures, Dollar index and 30 year T-bond contracts have been seesawing back and forth, one day up and another day down. For traders who practice the method of trend following, it has been quite a challenge. Partly because price movement has failed to follow through in any persistent fashion, trends have tended to be short lived causing these aforementioned traders to come into the market often late into the trend . This occurs because the confirmation of trend is typically happening at the top or bottom of the ranges.
The charts below show what a range-bound market looks like. These are the three markets I mentioned earlier. Notice the lack of follow-through, or trending, in all three of these markets.
In a conventional sense, most traders would want to see price “breakout” of these ranges and continue trending. These consolidation phases occur as market participants are undecided as to the future direction of prices. They would rather see other traders push prices outside of the range before committing to either buying or selling.
That’s fine except for the fact that when you wait for prices to leave the range, you will not find the lowest risk entry points. The simple reason is that price is usually high when breaking the upper part of the range and low as it falls through the lower boundaries of the consolidation.
Instead, an alternative way to trade a range bound market would be to look at the top of the range as a selling zone, and the bottom of the range as an area that provides buying opportunities. These trading opportunities would come in the smaller time frames.
An example of these is shown below in the 240 min chart of the E-mini S&P 500 futures contract.
Notice that shorting around the 2100 to 2105 area (top of the daily range) produced very profitable trades to the downside. Similarly, buying in the 2029 to 2035 zone (bottom of the lower range) made for very good long trades. We also know that markets don’t stay range bound forever. So, it’s inevitable that indeed, they will break-out of these ranges. When they finally do, the trader using this technique will stop out with a small loss.
Incidentally, just because a market breaks the upper part of the range, it’s not necessarily an indication that it will go higher. There are many instances where breakouts are false which means they reverse, quickly trapping those unsuspecting traders that subscribe to the traditional technical analysis method of trading. And yes, some of the time breakouts have a strong move in the same direction. The only challenge with buying or selling the “breaks” is that these entries are not low-risk.
All told, markets that are trading in a wide range don’t have to be challenging, as they provide great opportunities for those that have a sound, low-risk strategy. And in addition, for those traders that understand the different environments that markets routinely fall into, the array of possibilities is endless.
Until next time, I hope everyone has a great week.