A Guide to Range Trading
In financial markets, whether it’s Crypto, Stocks, or Forex, the price action of assets often tends to trade within specific ranges for extended periods of time. Having the ability to identify a ranging market, deconstruct it, and develop effective trading strategies is a valuable skill that can significantly enhance your trading efficiency and enable you to execute trades more effortlessly.
DISCLAIMER: The information provided in this post is for educational and recreational purposes only. None of the words or statements should be construed as financial advice. I am not a financial advisor, and any decisions made based on the content of this post are at your own risk.
The content of this article is primarily focused on crypto trading but may have applicability to other markets.
WHAT IS A RANGE IN PRICE ACTION?
A range in price action is a price chart pattern where the price of an asset is confined between a support level (bottom of the range) and a resistance level (top of the range). In this pattern, price fluctuates within this defined range, moving up and down as it bounces off the support and resistance levels. Ranges occur due to the trading activity of buyers and sellers in the market. Buyers enter the market when the price reaches the support level, while sellers enter when it reaches the resistance level. This battle between buyers and sellers continues until one side eventually gains dominant control and a breakout occurs, leading to a significant price movement beyond the range.
LEVELS IN A RANGE
In a range, there are typically three crucial levels to consider.
The first level is the range high or range top, which acts as a resistance level. At this level, there is typically increased selling pressure as traders are more inclined to sell the asset.
The second level is the range low or range bottom, which serves as a support level. Here, buying pressure tends to come into play as traders are more inclined to buy the asset.
Finally, there is the mid-level, which is the median point between the range top and range bottom. This level represents the middle of the range.
These three levels play a vital role in making trade decisions when trading ranges. Understanding the dynamics and interactions between these levels can provide valuable insights for determining potential entry and exit points within the range.
TYPES OF RANGES
Ranges in financial markets can manifest in various patterns and shapes. While there are different types of ranges, one of the most important and practical ones is the horizontal range.
A horizontal range is characterized by parallel lines or levels extending from left to right on a price chart. It represents a consolidation of price between a support level and a resistance level. This type of range is particularly significant as it provides clear boundaries for traders to observe and analyze price movement within a confined range.
Although other patterns such as wedges, triangles, and pennants can also be considered types of ranges (based on the theory that a range is a result of price consolidation within a constraining level of support and resistance), this article primarily focuses on horizontal ranges due to their prevalence and relevance in trading strategies.
WHY DO MARKETS RANGE?
Ranges form as a result of certain market dynamics following significant price movements. Understanding the philosophy behind range formation is essential when it comes to trading within ranges. Generally, two scenarios can occur after a significant price dump or pump, one leads to the formation of ranges and the other, otherwise.
Scenario one: In the case of a dump for example, sellers initially dominate and drive the price lower. However, a sudden influx of prepared buyers with substantial orders enters the market at a particular price area, creating a surge in buying pressure and volume. This cumulative buy pressure becomes greater than the initial cumulative sell pressure, resulting in a powerful reversal or pump as prior sellers begin to take profits or leave the market, surrendering the dominance to buyers. This scenario, known as a "V reversal" or "pump and dump," is usually event-driven (important news for example) and relatively rare, although it may occur more frequently on lower time frames or in highly volatile assets.
Scenario two: Using the same example of a dump, if the initial sell pressure gradually diminishes and no significant new buying volume emerges, the dump starts to slow down. Sellers begin taking profits, forfeiting control which leads to a gradual balance between sell and buy pressure as volatility subsides. This balance creates a situation where buyers and sellers engage in a battle for dominance. Since buying and selling pressure can never be perfectly equal, there will always be a slight imbalance. This ongoing struggle between buyers and sellers, with control shifting back and forth, eventually results in the formation of a range. Sellers defend resistance levels, pushing the price down in an attempt to break the buyers' support level, while buyers defend support and attempt to break out by attacking resistance. The battle continues until one side eventually wins and cause a breakout of price from the range. Ranges make up a significant portion of price action, estimated to be around 70% (in my opinion), when observed closely enough.
HOW TO DRAW HORIZONTAL RANGES ON PRICE CHART.
Drawing horizontal ranges on a price chart can be done using various tools and techniques. Using the Tradingview platform, you can draw a horizontal range using different types of lines and measuring tools or by using the already set ‘Parallel channel’ tool
APPROACH #1: Using line and measuring tools.
1. Using the TradingView platform, select the appropriate drawing tool for drawing lines from the toolbar. There are different options available, such as the horizontal ray/line tool or trendline tool.
2. Begin by identifying the resistance level. This is the level where sellers typically enter and push the price downward. Draw a horizontal line at this level on the chart.
3. Next, identify the support level. This is the level where buyers tend to step in and prevent the price from dropping further. Draw another horizontal line at this level.
4. To mark the mid-range, use the Fibonacci retracement tool. Measure the vertical distance between the support and resistance levels. Then, select the Fibonacci retracement tool and mark the horizontal line at the 50% Fibonacci retracement level (0.5). This line represents the midpoint of the range.
By using this method, you can visually identify and mark the key levels of a horizontal range on the price chart. It provides a clear visual representation of the range boundaries and the midpoint, which can be helpful for analyzing price action and making trading decisions within the range.
Feel free to adjust this approach based on your own preferences and trading style. The goal is to draw lines that accurately represent the support, resistance, and mid-range levels within the horizontal range.
APPROACH #2: Drawing ranges with the parallel channel tool.
1. Locate the toolbar in TradingView and select the 'lines' category.
2. Within the lines category, choose the 'parallel channel' tool. This tool allows you to draw parallel lines to define the range boundaries.
3. Start by connecting the first line either at the support or resistance level. Click on a starting point and drag the line to the opposite level, expanding it to encompass the range.
4. The parallel channel tool automatically includes a dashed mid-level line. This line represents the midpoint of the range.
5. Double-click on the drawn channel to access the settings. By adjusting the settings, you can customize the appearance of the parallel channel to suit your preferences.
For maximum ease of use, you can copy the specific settings shown in the image provided below, ensuring a comfortable and convenient experience while working with the tool.
Using the parallel channel tool offers a straightforward way to visually represent and identify the range boundaries, as well as the mid-level within the range.
THE RANGE TRADING STRATEGIES
Here are range trading strategies I have learnt and developed to take advantage of price movement within a range:
- THE BASIC STRATEGY
The simplest strategy to trade a range is to play it level to level until a breakout eventually occurs. There are three basic levels within a range, The range high, the range low and the mid-level. The general rule is to buy at support and sell at resistance. When price approaches the top of the range, we are prepared to execute sell orders to ride the price back down and when price approaches the bottom, we are prepared to buy the support back up into the resistance level of the range high. But because the market is not 100% perfect. Price sometimes bounce at the mid-level before reaching the other extreme, to manage risk and protect profits, it is advised to take some profits off at the mid-level (say 50% or 20% of the position), and move your stop loss to break even. To summarize, the formula for this strategy is = Buy at Range low or sell at Range high, secure some profits of the trade at mid, move stop loss to break even and leave the remaining position to run for the RH or RL.
2. THE LIQUIDITY-GRAB STRATEGY
The liquidity-grab strategy is based on the concept of liquidity levels and liquidity grabs. It's important to have prior knowledge about liquidity and how liquidity levels are formed.
In certain markets, especially in the cryptocurrency market, liquidity levels are commonly observed. These levels are created when there is a concentration of orders placed by numerous traders at a specific price point. Typically, these price points coincide with the highs or lows of a price swing. Traders often set their stop loss, take profit, or limit orders around these levels. Liquidity levels are not easily visible on charts and require a deeper understanding of market dynamics to identify them accurately.
Liquidity grabs, also known as stop-loss hunts, occur when the price moves into a liquidity level where a significant number of stop-loss orders have been placed. This movement triggers the execution of these stop-loss orders, resulting in a reversal effect. After the stop losses have been triggered at a liquidity level, the price tends to reverse in the opposite direction it was initially moving. This reversal happens due to the opposing pressure from new liquidity entering the market, provided that the volume generated by the liquidity grab is strong enough to counter the original volume impulse. As a result, candlestick patterns may fail to close above or below the liquidity level, continuing the overall trend.
The liquidity-grab strategy aims to capitalize on these liquidity levels and the subsequent price reversals. By identifying liquidity levels and anticipating liquidity grabs, traders can position themselves to take advantage of these market movements. It requires careful analysis and understanding of market dynamics, including volume and order flow, to effectively implement this strategy.
Note: In liquidity grab setups, it is commonly observed that the candlestick fails to close above the liquidity level, resulting in only wicks or shadows above the level. This characteristic is significant in identifying a potential liquidity grab scenario.
APPLYING THE LIQUIDITY-GRAB STRATEGY TO TRADE RANGES
When applying the liquidity-grab strategy to trade ranges, it's important to consider the relationship between liquidity levels and the support and resistance levels within the range.
In a range, where price bounces between a support level and a resistance level, each bounce creates a pivot point. Traders entering the market often set their stop-loss orders at these pivot points. Consequently, these pivot points become liquidity levels, as there is a concentration of stop-loss orders placed at those levels.
Liquidity levels are particularly significant in range trading. As price continues to move within the range, setting new pivots at support and resistance, traders setting their stop-loss orders at these pivot points contribute to the liquidity at those levels. Thus, liquidity levels tend to form at the range high and range low.
To trade the liquidity-grab strategy within ranges, pay close attention to liquidity levels that form at the resistance (RH) or support (RL) levels. These levels indicate areas where stop-loss orders from losing traders cluster. When price reaches a liquidity level and a liquidity grab occurs, observe how the opposing pressure from the grab affects the price. If the opposing pressure is strong enough to reverse the initial price movement, it can be a trigger for a potential counter-trend trade. Take trades in the opposite direction, aiming to capture the price movement as it reverses back toward the opposite range level. Remember to treat the market as ranging as long as the price remains within the range and trade within the range until a breakout happens. Use the examples shown in the chart below as illustrations and guidance for implementing the strategy effectively.
3. THE DEVIATION STRATEGY
The deviation strategy involves trading price movements that attempt to break out of a range but fail and fall back into the range. These failed breakouts are referred to as deviations or fakeouts.
Trading deviations can be challenging as it's often difficult to determine whether a price movement outside the range is a genuine breakout or a fakeout.
Professionals use indicators of strength and weakness, such as volume, open interest, and price action, to assess the likelihood of a current price action outside the range being a fake out. Significant volume spikes, impulsive candlestick bars, and increasing open interest are typically signs of a genuine breakout. These indicators indicate the presence of sufficient fuel or strength for an asset to break out from the range barrier. When these signs are present, a breakout occurs, and a new trend usually follows.
However, it’s advisable to wait for price to come back into the range before reaching a final conclusion. Waiting for price confirmation by re-entering the range helps to avoid premature judgments. It provides an opportunity to assess whether the attempted breakout was a genuine breakout or a fakeout.
HOW TO TRADE THE DEVIATION STRATEGY
Trading the deviation strategy involves taking advantage of price deviations from a range. When price attempts to break out of a range but fails and falls back into the range, trading opportunities arise. The safest and easiest way to trade this strategy is to wait for price to come back into the range and be accepted by the market.
Once price is accepted back into the range, the original plan of range trading can be continued. Depending on the direction price was moving before the deviation, you can trade from the top to the bottom or vice versa within the range. The idea is to resume the range play after the short break caused by the deviation.
To implement this strategy, observe an already defined range and be prepared for a potential breakout or fake out when a range barrier is being tested. If price breaks a barrier and then comes back to start closing candles inside the range, it indicates acceptance back into the range. This becomes a trade signal to take positions and continue the range play from the high to the low or vice versa.
By waiting for price acceptance back into the range before entering trades, you can increase the probability of success and reduce the risk of false breakouts. It’s important to have a well-defined range and use price confirmation signals to validate the re-entry into the range.
5. RANGE BREAKOUTS
Remember that price action of ranges is a result of the constant battle between buyers and sellers. Ranges form when the buying pressure and selling pressure are relatively balanced while trends occur when one side gains clear control. Eventually, a winner emerges from this battle, even if it means fighting to the death. Ranges cannot persist indefinitely, so breakouts are inevitable.
When trading within a range, it is essential to make the most of the opportunities that arise and be prepared for potential breakouts. However, it’s important to be cautious of fake outs. A typical range presents multiple trading opportunities, with an average of around 4 to 10 trades, before a breakout eventually occurs.
CONCLUDING TIPS
Incorporating liquidity grabs and deviations into your trading strategy can increase your trading efficiency and confidence. Pay attention to these patterns at the top and bottom of your range. Also, be aware of potential price reversals at the middle point of the range. Manage your trades wisely, taking profits at appropriate levels. Stay adaptable and disciplined in your approach for long-term trading success.
