Range trading is one of the most commonplace methods of trading in any financial market, including stocks, bonds, equities, and of course foreign currency exchange.
In range trading, traders will seek out two important upper and lower lines. These two upper and lower lines from the very famous support and resistance lines. Then with the help of these two upper and lower lines the so-called range is formed.
And in this range is where the trader will seek out to enter into positions and execute trades to obtain as much profit as possible. In this article, we are going to take an in-depth look at range trading, its definition, how it works, and how traders can use this method to their benefit.
What Is the Definition of Range Trading?
At the heart of range trading, we have the formation of the range. The range is basically a channel. So, in range trading, the trader will not merely trade based on lines or prices movements that are linear. Rather, trades will take place in a channel or range.
This channel is created through the distance that exists between support and resistance lines. And the support and resistance lines themselves are formed as follows: during the given time period, all the highs recorded for the price of the asset or currency pair in forex are connected to each using a horizontal line. This horizontal trend line would naturally form the higher standing resistance line.
On the other side of the equation, when the trader makes a connection between all the lows registered the resulting trend line would form the support line.
When this distance is created between two trend lines, the trader can take advantage of this range and execute trades. The way trades are executed, on average, using the range trading strategy is that the trader would opt to assume a long position(Long Position in Forex) when price moves close to the bottom half of the channel. On the other hand, it would prove beneficial if the trade assumed a short position when prices lean more toward the upper half of the range, i.e. closer to the upper trend line of resistance.
But as with any other trading strategy, range trading ought not to be used alone. Using any strategy solely and without the help of any other tool, will result in a phenomenon known as tunnel vision.
Tunnel vision in any market is a limited and constrained analysis that will ultimately lead to undesirable results. To get yourself out of tunnel vision, you need to use other tools and techniques in conjunction with the strategy you have chosen.
For instance, in the case of range trading, traders would normally use other indicators that provide data with regard to volume.
Trading volume data can help improve the chances of successful trades with range trading.
How Does Range Trading Work?
The most important aspect of range trading is the identification of trend lines. So any strategy that can help traders identify these lines will be used at first for the formation of resistance and support lines. Remember, it is within these lines that the range for trading exists.
Prior to the formation of the upper and lower trend lines, it is important to make sure that the resulting support and resistance lines are powerful enough. If the chosen trend lines are weak, they can easily be broken through to set new trends.
For a trend line to be powerful, prices need to have rebounded from them multiple times. For instance, if a resistance line is only touched three times by prices following a rebound, then the support line may not be as strong. But if the same line is touched, for example, six or seven times, then this support line is more reliable.
How Do Traders Benefit from Range Trading?
Building on what has been just mentioned in the previous section, it is absolutely crucial that the support and resistance lines that are found are strong.
Because that is the entire premise on which the trader will make profits using range trading. If the two lines are reliable enough, then the trader can rest assured that prices will keep bouncing back and forth between the lines and keep within the range.
In this situation, as a trader you can keep buying near the support line and selling near the resistance line. This won’t last forever, obviously. But for however much long it lasts, this form of trading can bring you steady and reliable profits.
What Is the Biggest Challenge of Range Trading?
With any trading strategy, there are a certain number of challenges that if go unheeded can crash your trades and incur losses. The same is true for range trading.
But perhaps among all the possible challenges, the biggest one has to do with the miscalculation of support and resistance lines. As discussed in the previous section, the entire premise behind range trading is that you are certain the range will hold. So you keep trading in the range, buying low and selling high.
But if there is any mistake in the calculation of these two bounds that make up the channel in range trading, then the trader can easily be fooled into thinking that they are buying low or selling high, when in fact the supposed trend line will be broken through.
When the support or resistance line is broken through, then naturally they are no longer support nor resistance.
But there are precautionary methods in place to help save you from making such mistakes. One such method is the use of stop loss orders.
What Is the Role of Stop Loss in Range Trading?
Even the sharpest and the best traders make mistakes sometimes. One way to make sure that you can be safe from wrong calculations is through the placement of stop loss orders.
In range trading, a common way of placing stop loss orders is just above the support and resistance lines.
In this way, it doesn’t matter if your most recent position has been buying at low or if you are going to sell at high, the stop loss will make sure that your total losses are kept to a minimum.
What Techniques Are Used with Range Trading?
As was mentioned before, any technical indicator that can help traders find support and resistance levels is naturally useful in range trading strategy. Among these indicators we can name the relative strength index and stochastic indicator.
Range trading is one of the most reliable trading strategies. Provided that the trader has made the analysis and calculations in the correct way. In range trading, the trader will find the two upper and lower trend lines of support and resistance, between which the range or channel exists. Then the trader will use this bound to buy low and sell high.