A. Range-Bound Market
When the market is in an established range and the price approaches one extreme of the range, there are only two things that can happen: the price can reverse and move back to the other end of the range, or the price can break out of the range. These two possible outcomes determine the two main strategies for the range-bound market. A trader can either trade within the range or attempt to take advantage of the price moving outside of the range. When done using proper setups, either setup can result in a trade with a good risk: reward ratio and a high chance of success.
Determining if the Market is Range-Bound or Trending
Do not make this process more difficult than it really is. From a first impression you should be able to determine if the market is in an up, down, or sideways trend. An uptrend would consist of a series of higher highs and higher lows. A downtrend would be lower highs and lower lows. And a sideways market would be one that has no clear pattern of either of these. If relative high and low points are near the same level, the market is said to be range bound. The following would be a sideways or range-bound market for most of the chart.
Indicators to use in a Range-Bound Market
Oscillators (RSI, MACD, Stochastic)— Divergence is not likely to be a factor in a range-bound market, since it depends on the price making new highs or lows while the oscillator does not. Far more likely will be overbought/oversold readings on the oscillators and crossovers on MACD and stochastic. Since MACD can be several candles too slow to provide for a good entry point, always compare the price to support/resistance before placing the trade.
Bollinger Bands— Bollinger Bands can signal whether the trade is going to reverse or break out of a range. If the bands start to widen at one extreme of the trading range, it is a signal that volatility is increasing and a breakout is more likely. If they remain narrow or horizontal, the price is more likely to touch the bands and move back within the range.
Support/Resistance from Relative Highs/Lows— Relative high and low points are critical to success in a range-bound market. Relative highs form resistance and relative lows create support. If there are a great many of these points on the same line, support or resistance can become extremely strong. Taking a short below resistance or buying above support can result in a low risk trade, since you know where the market is likely to reverse. If it does not reverse at that point, then you have a precise level where you should exit the trade.
Candlestick Patterns— There are three main types of short-term candlestick patterns: bearish, bullish and indecisive. It only makes sense that a bearish signal below resistance is a good sign to take a short. An indecisive pattern like a doji that appears below resistance would not be as strong. In fact, if the price moved above the high of the doji and through resistance, the doji would help encourage a long position.
Breakout vs. Range-Bound
The following chart shows two points, A and B, where the market first reversed at the top of the range and then broke out with very similar signals. Let’s examine how you might determine to take a short position at A and buy at B. First there are the Bollinger Bands. At A they are essentially horizontal, while at B they have started to expand. Second is the MACD. At A, there is a negative divergence (rare in a range-bound market, but not unheard of), while at B MACD is making new highs. Most important though, is the fact that at A, the price moved above the resistance line and fell back down, while at B, the daily candle closed above resistance. Once the price moved above the red line and closed there, this was a signal to buy once the price moved above the high for the blue candle. Though it took several days for the trade to develop, it eventually did so and the price rose higher.
B. Trending Markets
Trending markets can be trickier to trade than range-bound markets, even though the price seems to be moving in a clear direction. If the price is in a range, it is often easy to identify the extremes of the range and trade accordingly. With a trending market, it is often easy to identify the trend, but it is difficult to determine entry points within the trend or determine whether the trend is over. As stated previously, a trending market would be identified by a series of higher highs and higher lows or lower highs and lower lows.
The relative highs create horizontal resistance levels in this uptrend, and the relative lows can often be connected to form support levels.
Just like in a range-bound market, the price can do only one of two things as it approaches one of these support or resistance levels: breakthrough or reverse. This should be at the center of how to plan trades in a trending market.
Indicators to use in a Trending Market
Trend lines that support the trend—Just as is illustrated above, trend lines can provide excellent
opportunities to buy on a pullback in the trend or to sell against the trend if the price breaks through a significant trend line such as this one.
Fib Retracement Levels—If the market is starting to pullback from its trend (retracing lower in an uptrend for example), Fib levels can show where to reenter the market on the side of the original trend. As discussed in Lesson 5, the price should retrace slightly below the Fib level, move back above it, and then the trader should enter on the side of the trend.
Moving Averages as Support or Resistance—Just as trend lines and Fib levels can be used to gauge where pullbacks should end and opportunities to buy on a bounce will exist, moving averages that trail behind a trend are excellent points to reenter the market on the side of the trend. The longer the MA, the more significant Support/Resistance it will offer, so a price retracing past a 50 day EMA, for example, would be a strong sign of a reversal in the trend.
Oscillators for Divergence—Though overbought/oversold readings are less important during a trending market than they would be during a range-bound one, oscillators that diverge from the trend are an early warning signal that the trend may be about to reverse. Traders in such cases should look for the failure of such signals as trend lines, MA’s, and Fib levels that should support the trend.
When to Follow or Abandon the Trend
Compare Points A and B on the following chart. Let’s look at why A was a good buy and B was a good sell (aside from the fact that the price went up following A and went down following B). This chart is a perfect example of the 20 day EMA acting as support. Note how many times the price bounces off the support lineand continues the trend. At A, the price is still above the 20 day EMA, so this is a buy signal. At A as well, the price is just above the trend line connecting the relative low points. By the time the price reaches A, the trend line has held at least 5 or 6 different times, so it should be considered very strong. The price has not retraced significantly at all at this point, though, so Fib levels are not relevant to the trade. It could be argued that RSI is showing divergence at A, but this is only a vague heads up to look for places to short.
All other signals are strong buys.
At B, RSI shows a clear divergence. More importantly, though, the price has closed below both the 20 EMA and the trend line. This has happened once before B, but if we use the standard entry point in case of a breakout, we could have avoided selling too soon. Once a candle closes below the trend line, the entry point would be to sell on the following day if the price goes below the low of the breakthrough candle. This does not happen before B, but it does happen just after B. By using a stop sell order to enter the market, a trader can ensure that the momentum is on the same side of the trade at the entry point. B turns into a real break of the support line.
Determining if the Market is Range-Bound or Trending
Do not make this process more difficult than it really is. From a first impression you should be able to determine if the market is in an up, down, or sideways trend. An uptrend would consist of a series of higher highs and higher lows. A downtrend would be lower highs and lower lows. And a sideways market would be one that has no clear pattern of either of these. If relative high and low points are near the same level, the market is said to be range bound. The following would be a sideways or range-bound market for most of the chart.
Indicators to use in a Range-Bound Market
Oscillators (RSI, MACD, Stochastic)— Divergence is not likely to be a factor in a range-bound market, since it depends on the price making new highs or lows while the oscillator does not. Far more likely will be overbought/oversold readings on the oscillators and crossovers on MACD and stochastic. Since MACD can be several candles too slow to provide for a good entry point, always compare the price to support/resistance before placing the trade.
Bollinger Bands— Bollinger Bands can signal whether the trade is going to reverse or break out of a range. If the bands start to widen at one extreme of the trading range, it is a signal that volatility is increasing and a breakout is more likely. If they remain narrow or horizontal, the price is more likely to touch the bands and move back within the range.
Support/Resistance from Relative Highs/Lows— Relative high and low points are critical to success in a range-bound market. Relative highs form resistance and relative lows create support. If there are a great many of these points on the same line, support or resistance can become extremely strong. Taking a short below resistance or buying above support can result in a low risk trade, since you know where the market is likely to reverse. If it does not reverse at that point, then you have a precise level where you should exit the trade.
Candlestick Patterns— There are three main types of short-term candlestick patterns: bearish, bullish and indecisive. It only makes sense that a bearish signal below resistance is a good sign to take a short. An indecisive pattern like a doji that appears below resistance would not be as strong. In fact, if the price moved above the high of the doji and through resistance, the doji would help encourage a long position.
Breakout vs. Range-Bound
The following chart shows two points, A and B, where the market first reversed at the top of the range and then broke out with very similar signals. Let’s examine how you might determine to take a short position at A and buy at B. First there are the Bollinger Bands. At A they are essentially horizontal, while at B they have started to expand. Second is the MACD. At A, there is a negative divergence (rare in a range-bound market, but not unheard of), while at B MACD is making new highs. Most important though, is the fact that at A, the price moved above the resistance line and fell back down, while at B, the daily candle closed above resistance. Once the price moved above the red line and closed there, this was a signal to buy once the price moved above the high for the blue candle. Though it took several days for the trade to develop, it eventually did so and the price rose higher.
B. Trending Markets
Trending markets can be trickier to trade than range-bound markets, even though the price seems to be moving in a clear direction. If the price is in a range, it is often easy to identify the extremes of the range and trade accordingly. With a trending market, it is often easy to identify the trend, but it is difficult to determine entry points within the trend or determine whether the trend is over. As stated previously, a trending market would be identified by a series of higher highs and higher lows or lower highs and lower lows.
The relative highs create horizontal resistance levels in this uptrend, and the relative lows can often be connected to form support levels.
Just like in a range-bound market, the price can do only one of two things as it approaches one of these support or resistance levels: breakthrough or reverse. This should be at the center of how to plan trades in a trending market.
Indicators to use in a Trending Market
Trend lines that support the trend—Just as is illustrated above, trend lines can provide excellent
opportunities to buy on a pullback in the trend or to sell against the trend if the price breaks through a significant trend line such as this one.
Fib Retracement Levels—If the market is starting to pullback from its trend (retracing lower in an uptrend for example), Fib levels can show where to reenter the market on the side of the original trend. As discussed in Lesson 5, the price should retrace slightly below the Fib level, move back above it, and then the trader should enter on the side of the trend.
Moving Averages as Support or Resistance—Just as trend lines and Fib levels can be used to gauge where pullbacks should end and opportunities to buy on a bounce will exist, moving averages that trail behind a trend are excellent points to reenter the market on the side of the trend. The longer the MA, the more significant Support/Resistance it will offer, so a price retracing past a 50 day EMA, for example, would be a strong sign of a reversal in the trend.
Oscillators for Divergence—Though overbought/oversold readings are less important during a trending market than they would be during a range-bound one, oscillators that diverge from the trend are an early warning signal that the trend may be about to reverse. Traders in such cases should look for the failure of such signals as trend lines, MA’s, and Fib levels that should support the trend.
When to Follow or Abandon the Trend
Compare Points A and B on the following chart. Let’s look at why A was a good buy and B was a good sell (aside from the fact that the price went up following A and went down following B). This chart is a perfect example of the 20 day EMA acting as support. Note how many times the price bounces off the support lineand continues the trend. At A, the price is still above the 20 day EMA, so this is a buy signal. At A as well, the price is just above the trend line connecting the relative low points. By the time the price reaches A, the trend line has held at least 5 or 6 different times, so it should be considered very strong. The price has not retraced significantly at all at this point, though, so Fib levels are not relevant to the trade. It could be argued that RSI is showing divergence at A, but this is only a vague heads up to look for places to short.
All other signals are strong buys.
At B, RSI shows a clear divergence. More importantly, though, the price has closed below both the 20 EMA and the trend line. This has happened once before B, but if we use the standard entry point in case of a breakout, we could have avoided selling too soon. Once a candle closes below the trend line, the entry point would be to sell on the following day if the price goes below the low of the breakthrough candle. This does not happen before B, but it does happen just after B. By using a stop sell order to enter the market, a trader can ensure that the momentum is on the same side of the trade at the entry point. B turns into a real break of the support line.
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