What Is Range-Bound Trading?
Range-bound trading is a trading strategy that seeks to identify and capitalize on securities, like stocks, trading in price channels. After finding major support and resistance levelsand connecting them with horizontal trendlines,a trader can buy a securityat the lower trendline support (bottom of the channel) and sellit atthe upper trendline resistance(top of the channel).
Key Takeaways
- A range-bound trading strategy refers to a method in which traders buy at the support trendline and sell at the resistance trendline level for a given stock or option.
- Traders place stop-loss points just above the upper and lower trendlines to avoid having heavy losses from high-volume breakouts.
- Typically, traders use range-bound trading in conjunction with other indicators, such as volume, in order to increase their odds of success.
Understanding Range-Bound Trading
Range-bound trading strategies involve connecting reaction highs and lows with horizontal trendlines to identifyareas of support and resistance. The strength, or reliability, of the trendline as an area of support or resistance depends on the number of times the price has reacted to it. For example, if the price has moved lower off of the resistance trendline five or four times, it's considered more reliable than if the price only moved off of it two times.
A trading range occurs when a security trades between consistent high and low prices for a period of time. The top of a security’s trading range often provides priceresistance, while the bottom of the trading range typically offers price support.
Traders capitalize on range-bound trading by repeatedly buying at the support trendline and selling at the resistance trendline until the security breaks out from a price channel. 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 favor, although it's important to always watch for a potential breakout or breakdown.
Most traders place stop-loss points just above the upper and lower trendlines to mitigate the risk of heavy losses from a high volumebreakout or breakdown. For example, if a security has a lower support trendline at $10.00 and an upper resistance trendline at $15.00, the trader may purchase the stock at $11.00, just after a rebound, with a stop-loss of $9.00. This protects the trader if the stock broke down from the support trendline.
Many traders also use other forms of technical analysis in conjunction with price channels to increase their odds of success. For instance, traders might watch the volume associated with a rebound from a support level to gauge the likelihood of a breakdown or breakout. The relative strength index (RSI) is also a useful indicator of the trend strength at any given point within a price channel.
Range-Bound Trading Example
The following chart shows an example of a range-bound trading strategy with arrows in place for potentially long and short trades.
:max_bytes(150000):strip_icc()/dotdash_INV_final-Range-Bound-Trading_Feb_2021-01-8f92f4f806ea464e84c0787f363a01ec.jpg "What Is Range-Bound Trading? Definition and How Strategy Works (1)")
In this chart, a trader may have noticed that the stock was starting to form a price channel in late October and early November. After the initial peaks were formed, the trader may have started placing long and short trades based on these trendlines, with a total of four short trades and two long trades. The stock's breakout from upper trendline resistance marks an end to the range-bound trading.
Trading Range Strategies
Support and Resistance:If a security is in a well-established trading range, traders can buy when the price approaches support and sell when it reaches resistance. Technical indicators, such as the relative strength index (RSI),stochastic oscillator, and the commodity channel index (CCI), can be used to confirm overbought and oversold conditions when price oscillates within a trading range.
For example, a trader could enter a long position when the price of a stock is trading at support and the RSI gives an oversold reading below 30. Alternatively, the trader may decide to open a short position when the RSI moves into overbought territory above 70. A stop-loss order should be placed just outside of the trading range to minimize risk.
Breakouts and Breakdowns:Traders can enter in the direction of abreakoutor breakdown from a trading range. To confirm the move is valid, traders should use other indicators, such as volume and price action.
For instance, there should be a significant increase in volume on the initial breakout or breakdown, as well as several closes outside the trading range. Instead of chasing the price, traders may want to wait for aretracementbefore entering a trade. For example, a buy limit order could be placed just above the top of the trading range, which now acts as a support level. A stop-loss order could sit at the opposite side of the trading range to protect against a failed breakout.
