Trading Both Sides Of The Charts With Trading Ranges

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Trading Both Sides Of The Charts With Trading Ranges

What do I mean? Trading bear positions as well as trading bull positions. I know that I, and I suspect many newbies and advanced traders as well, started out learning to trade bull positions. It is easier and only natural as the tendency in trading and stock ownership is to buy low and then sell high. Another thing that may keep the average trader from entering a short or otherwise bullish position is margin and other account requirements associated with futures, forex and standardized options. The good news for binary options traders is that there is no limitation on your account and what you can trade so bearish strategies and techniques can be used with equal relish as bull ones, provided you make the right trades. That I think is the real reason why so many traders stick to bullish trading and/or have so much trouble trading bearish positions; they aren’t making the right trades.

When Not To Trade Bearish

There is one certain time when you should not make a bearish trade; when the market is bullish. This is a common mistake made by many new traders and I can say that because I have done it; trying to get bearish when the market is bullish. In general, even when we’re in a secular or long term bear market, the market is bullish. People want to buy stocks and when we are in a protracted bear market it is not so much because there are so many shorts in the market as it is that the buyers disappear. So, when the market is bullish it is not usually a good time to trade bearish but when is a good time? There are two key times in the market cycle when bearish positions are not only OK, but the preferred method of trading. The first is when the market is range bound and trending sideways, the second is when the market is in a well defined down trend. What makes up a well defined down trend may vary from trader to trader and depends greatly on time frame but once found is a fountain of profitable trades but that is for another time.

Trading A Range With Bear Positions

Ranges are great places to trade in a number of ways that include both bull and bear positions. The tops and bottoms of ranges are fantastic areas to look for reversal signals in the candlesticks and the indicators. In fact, ranges are perhaps the best place to use overbought and oversold readings on an oscillator. If the asset is up at, near or piercing the upper end of a range with overbought conditions on an indicator such as stochastic, RSI or MACD then chances are good a bearish strategy is the one you want. How do you know where the top of a range is? Usually it will be marked by a series of peaks or tops that stop at the same level with corresponding dips or bottoms that likewise stop at the same level. Look at the chart below. This a chart of daily price action for the EUR/USD US session. You can see that the pair has traded in a range from October 2020 until June 2020. This range is marked by Fibonacci Retracement levels and confirmed by price action about a dozen times, at least 6 at the top providing profitable entry each time.

Once prices break above the 50% retracement line the first peak appears even before it reaches the next level. This peak is matched by a stochastic reading that enters overbought and produces a bearish crossover. The fact that the peak is appearing before reaching the next Fibonacci Level is one sign that prices will likely fall back to retest the 50% level and they do. The next signal is a bullish one but one that confirms a longer term range could be in play. The next peak, the next two peaks in fact, also occur once price approaches the upper range limit along with an overbought stochastic and bearish crossovers. Additionally, the first divergence is seen indicating an underlying weakness in the market. The next three peaks also come as price action reaches the upper limit of the range. They are also confirmed by overbought stochastic readings, bearish crossovers and a growing divergence that leads to a protracted visit to the low end of the range. The thing to take not of here is that this is a ranging market, even if you only get into trades based on this strategy on the 3 rd or 4 th peak you have made two great trades.

I used Fibonacci Retracements as the basis for my range. You can use other methods to mark a range such as simple support and resistance lines. You also do not have to limit your self to any one time frame although I prefer to use daily charts. Hourly and 30 minute are just as useful, especially for day trading. Take a look at the chart above of the AUD/USD. This is a chart of daily prices with support and resistance drawn at likely places. Resistance is being tested while candle action supports the possibility of a range top. Even without the range theory in place this is an attractive area for bearish strategy and is confirmed by, you guessed, an overbought stochastic with a bearish crossover.

Click here for more information on trading with Fibonacci Retracments and here to learn about using oscillators like stochastic and RSI.

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Range-Bound Trading

Many traders spend a good portion of time looking for and identifying trends in stock charts, hoping to ride the next wave to profit. However, for some, sideways price action can be just as lucrative. When a security stops following a trend and instead oscillates between two prices, it becomes range-bound.

As the price bounces back and forth, it establishes identical, or nearly identical, highs and lows, creating an upper resistance level and a lower support level. While the limited upside potential may be frustrating for someone looking to ride a trend, the relative predictability of these highs and lows can mean easy money, albeit in smaller quantities.

Effective Strategies for Trading Range-Bound Securities

To effectively trade a range-bound security, it is essential to first confirm the range. 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 the range, or price channel, is established, the simplest trading strategy is simply to buy near the support level and sell near resistance. Alternatively, when trading options, one could purchase calls near support and sell puts near resistance. Of course, especially when it comes to options trading, veteran traders may use more complex strategies to play both sides of the bounce simultaneously.

Since the chief risk inherent in trading range-bound stocks is being on the wrong side of the breakout, it is important to pay close attention to any clues that might hint at when it will occur. Generally, a trading range is merely a pause before the continuation of a current trend or a period of indecision in the market before opposition forces a reversal.

Therefore, while it is tempting to simply set a stop-limit order near the support or resistance levels and trust the pattern, it is crucial to pay attention to other indicators, such as trading volume, that may indicate an impending breakout. If the price breaks downward through the support level, a prematurely purchased call can quickly be rendered worthless. A patient and conscientious trader can profit from the range and the breakout.

Range Bar Charts: A Different View of the Markets

Nicolellis range bars were developed in the mid-1990s by Vicente Nicolellis, a Brazilian trader and broker who spent over a decade running a trading desk in Sao Paulo. The local markets at the time were very volatile, and Nicolellis became interested in developing a way to use the volatility to his advantage. He believed price movement was paramount to understanding (and making profits from) volatility. So, Nicolellis developed the idea of range bars, which consider only price, thereby eliminating time from the equation.

Calculating Range Bars

Nicolellis found that bars based on price only, and not time or other data, provided a new way of viewing and utilizing volatility of financial markets. Most traders and investors are familiar with bar charts based on time. For instance, a 30-minute chart shows the price activity for each 30-minute time period during a trading day and each bar on a daily chart shows the activity for one trading day. Time-based charts will always print the same number of bars during each trading session, trading week, or trading year, regardless of volatility, volume, or any other factor.

Key Takeaways

  • Range-bar charts are different from time-based charts because each new bar in a range bar is based on price movement rather than units of time, like minutes, hours, days, or weeks.
  • Brazilian trader Vicente Nicolellis created range-bar charts in the mid-1990s in order to better understand the volatile markets at that time.
  • In volatile markets, many bars will print on a range bar chart, but range bars will be fewer in slow markets.
  • The ideal settings for range-bar charts depend on the security, price, and amount of volatility.

Range bar charts, on the other hand, can have any number of bars printing during a trading session: during times of higher volatility, more bars will appear on the chart, but during periods of lower volatility, fewer bars will print. The number of range bars created during a trading session will also depend on the instrument being charted and the specified price movement for each range bar.

Three rules of range bars:

  • Each range bar must have a high/low range that equals the specified range.
  • Each range bar must open outside the high/low range of the previous bar.
  • Each range bar must close at either its high or its low.

Settings for Range Bars

Specifying the degree of price movement for creating a range bar is not a one-size-fits-all process. Different trading instruments move in a variety of ways. For example, a higher-priced stock such as Google (GOOG) might have a daily range of $20 or $30; a lower-priced stock, such as Blackberry Limited (BB) might move only a fraction of that in a typical day. Blackberry Limited is the company previously known as Research In Motion (it is named as such in the charts below). It is common for higher-priced trading instruments to experience greater average daily price ranges.

Figure 1 shows both Google and Blackberry with 10-cent range bars. One-half of the trading session (9:30 a.m. to 1:00 p.m. EST) for Google can barely be compressed to fit on one screen since it has a much greater daily range than Blackberry, and therefore many more 10 cent range bars are created.

Figure 1: These charts compare two trading instruments’ daily activity shown with 10-cent range bars. Notice how the Google chart has many more 10-cent range bars than Blackberry. This is due to the fact the Google typically trades in a greater range. Only half of the trading session for Google could be squeezed into the upper chart; the entire trading session for Blackberry appears in the bottom chart.

Google and Blackberry provide an example for two stocks that trade at very different prices (one high and one low), resulting in distinct average daily price ranges. It should be noted that, while it is generally true that high-priced trading instruments can have a greater average daily price range than those that are lower priced, instruments that trade at roughly the same price can have very different levels of volatility, as well. While we could apply the same range-bar settings across the board, it is more helpful to determine an appropriate range setting for each trading instrument.

One method for establishing suitable settings is to consider the trading instrument’s average daily range. This can be accomplished through observation or by utilizing indicators such as average true range (ATR) on a daily chart interval. Once the average daily range has been determined, a percentage of that range could be used to establish the desired price range for a range bar chart.

Another consideration is the trader’s style. Short-term traders may be more interested in looking at smaller price movements and, therefore, may be inclined to have a smaller range-bar setting. Longer-term traders and investors may require range bar settings that are based on larger price moves.

For example, an intraday trader may watch a 10-cent (.01) range bar on McGraw-Hill Companies (MHP). This would allow the short-term trader to watch for significant price moves that occur during one trading session. Conversely, an investor might want one dollar (1.0) range-bar setting for the same stock, which would help reveal price movements that would be significant to the longer-term style of trading and investing.

Trading with Range Bars

Range bars can help traders view price in a “consolidated” form. Much of the noise that occurs when prices bounce back and forth between a narrow range can be reduced to a single bar or two. This is because a new bar will not print until the full specified price range has been fulfilled, and helps traders distinguish what is actually happening to price.

Because range-bar charts eliminate much of the noise, they are very useful charts on which to draw trendlines. Areas of support and resistance can be emphasized through the application of horizontal trendlines; trending periods can be highlighted through the use of up-trendlines and down-trendlines.

For example, figure 2 shows trendlines applied to a .001 range bar chart of the euro vs. U.S. dollar (EUR/USD) forex pair. The horizontal trendlines easily depict trading ranges, and price moves that break through these areas are often powerful. Typically, the more times price bounces back and forth between the range, the more powerful the move may be once price breaks through. This is considered true for touches along up-trendlines and down-trendlines: the more times price touches the same trendline, the greater the potential move once price breaks through.

Figure 2: This .001 range bar chart of EUR/USD illustrates the effectiveness of applying trendlines to range bar charts.

Figure 3 illustrates a price channel drawn as two parallel down-trendlines on a range-bar chart of Google. We have used a one range bar here, where each bar equals $1 of price movement and which does a better job of eliminating the “extra” price movements that were seen in Figure 1 using a 10-cent range-bar setting. Since some of the consolidating price movement is eliminated by using a larger range bar setting, traders may be able to more readily spot changes in price activity. Trendlines are a natural fit to range-bar charts; with less noise, trends may be easier to detect.

Figure 3: This 1 Range-bar chart of Google illustrates a price channel created by drawing parallel down-trendlines. The move to the upside was substantial once price broke above the channel.

Interpreting Volatility with Range Bars

Volatility refers to the degree of price movement in a trading instrument. As markets trade in a narrow range, fewer range bars will print, reflecting decreased volatility. As price begins to break out of a trading range with an increase in volatility, more range bars will print.

In order for range bars to become meaningful as a measure of volatility, a trader must spend time observing a particular trading instrument with a specific range-bar setting applied.

Through observation, a trader can notice the subtle changes in the timing of the bars and the frequency in which they print. The faster the bars print, the greater the price volatility; the slower the bars print, the lower the price volatility. Periods of increased volatility often signify trading opportunities as a new trend may be starting.

The Bottom Line

While not a technical indicator, range bars can be used to identify trends and to interpret volatility. Since range bars take only price into consideration, and not time or other factors, they provide traders with a unique view of price activity. Spending time observing range bars in action is the best way to establish the most useful settings for a particular trading instrument and trading style, and to determine how to effectively apply them to a trading system.

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