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Range Trading: A Simple Forex Strategy Explained

   

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Naturally, all traders are looking for the best technique to help them achieve their trading objectives. Range trading is an increasingly popular approach to the market, more people are looking to it as a means to take advantage of what the forex market has to offer. 

For some people, the idea of range trading—or even the term itself—is alien. But that is about to change. This article breaks down range trading, explaining what stands behind the strategy and how you can go about implementing it.

What Is Range Trading?

Range trading is a forex trading strategy that involves the identification of overbought and oversold currency (also known as areas of support and resistance). Range traders buy during oversold/support periods and sell during overbought resistance periods. 

Range trading can generally be implemented at any time, but it is most effective when the forex market lacks direction with no discernible long-term trend in sight. Range trading is at its weakest during a trending market, especially if market directional bias isn’t accounted for. Because of mostly sideways trending currency markets, 2017 was a great year for range traders.

 

Types of Range

Should you want to become a successful range trader, you’ll need to have a firm grasp on the types of ranges that stand behind the strategy. Here are the four most common types of range that you’re likely to come across.

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Rectangular Range

When you encounter a rectangular range, you’ll see sideways and horizontal price movements between a lower support and upper resistance. This is common during most market conditions, but not quite as common as continuation ranges or channel ranges. 

In the chart below, notice how the price movement of the currency pair stays within the upper and lower lines of resistance, creating an obvious rectangular range that sets clear parameters for identifying possible buy opportunities

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Even without indicators, it should be easy enough to spot horizontal ranges on a chart. Charts typically show clear support and resistance zones, a flattening of the moving average lines, and highs and lows lying within a horizontal band.

Pros: Rectangular ranges indicate a period of consolidation and tend to have a shorter time frame than other range types, which can lead to faster trade opportunities.

Cons: These ranges can mislead traders who don’t look for long-term patterns that may be influencing the development of a rectangle.

Diagonal Range

Diagonal ranges in the form of price channels are common forex chart patterns, and many range traders take a vested interest in them. The chart below illustrates a descending diagonal range that establishes upper and lower trendlines to help identify a possible breakout of this range:

Screen Shot 2019-11-12 at 8.21.23 AMIn a diagonal range, the price descends or ascends via a sloping trend channel. This channel can be rectangular, broadening, or narrowing.

Pros: With diagonal ranges, breakouts tend to happen on the opposite side of the trending movement, which gives traders a leg up in anticipating breakouts and earning a profit.

Cons: Although many diagonal range breakouts take place relatively quickly, some can take months or years to develop, which makes it tough for traders to make decisions based on when they expect a breakout to occur.

Continuation Ranges

A continuation range is a chart pattern that unfolds within a trend. Triangles, wedges, flags, and pennants all qualify, and these ranges usually occur as a correction against a predominant trend. The chart below shows a triangle pattern developing amid an existing price trend, resulting in a period of consolidation within a tight range:

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Continuation ranges can all be traded as ranges or as breakouts, depending on your trading time horizon. Bearish or bullish, continuation ranges can realistically occur at any time.

Pros: Continuation ranges can occur frequently in the middle of ongoing trends or patterns, and they often result in a quick breakout, which will satisfy traders who want to open a position and score a profit quickly.

Cons: Because continuation patterns take place within other trends, there is added complexity to evaluating these trades and accounting for all of the variables at play. This can make continuation ranges a little more tricky for novice traders.

Irregular Ranges

Most ranges don’t necessarily present an obvious pattern—at least, not at first glance. When a particularly irregular range unfolds, it tends to take place around a central pivot line, and resistance and support lines crop up around it. In the chart below, notice how a diagonal trend has taken shape within a larger rectangular range, creating new lines of support and resistance:

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In an irregular range, determining support and resistance areas can prove to be difficult, but it will present opportunities for those who like to tackle irregular ranges by trading toward the central pivot axis rather than at the extremes.

Pros: Irregular ranges can be a great trading opportunity for traders capable of identifying the lines of resistance making up these ranges.

Cons: The complexity of irregular ranges often requires traders to use additional analysis tools to identify these ranges and potential breakouts.

The Strategy Behind Range Trading

Plenty of active traders pursue range trading. Those looking to join the crowd will need to understand not just the types of range they’ll face but also the strategy behind using these ranges to full effect.

Identify the Range

To start off on the right foot, you’ll need to identify the trading range. This can be located after a currency has recovered from a support area—ideally, at least twice. The currency should also have retreated from a resistance area—once again, at least twice. It is not a requirement for these highs and lows to be similar in every way, but they should at least be close together. 

Some traders have a tendency to hold back until more than two highs and lows have occurred, but this is a matter of personal preference. After these highs and lows have occurred and subsequently been pinpointed, a straight line can link them on a chart, thus creating the currency trading range. 

Set Up Your Entry

With a trading range in your crosshairs, you’ll need to set up your entry. You can do this by buying near support levels and selling orders near resistance levels. To help with this, some use indicators (see oscillators such as the relative strength index and commodity channel index) as a means to place trades. Correctly using indicators should allow any trader to exhibit tighter control when setting up an entry, usually by obtaining a better sense of when to enter or exit a position. 

Manage Risk

With your range identified and your entry set up, you must not forget the final part of any effective range trading attempt. Risk management is always a crucial factor, no matter how you choose to trade, but it carries much more importance when you choose to range trade. Should a resistance or support level break, traders will rightfully want to walk away from a range-based position. 

Having a stop loss in effect can help when it comes to ensuring that range trading is risk-averse. Placing a stop loss above a previous high when selling the resistance zone of a range is often advised, and you can freely invert the process when buying support. Remember, when you’re range trading, your efforts will be most effective when appropriate risk management is in place.

Range trading doesn’t embrace the Wild West side of forex like other trading strategies; this strategy is actually on the tame side. Range trading has drawn some criticism that it is too simplistic for modern market conditions, but its relevance and popularity have never wavered. At its peak, range trading can become impactful during times when the forex market lacks a definitive direction. By identifying the range, timing your entry, controlling your risk exposure, and—most importantly—understanding the fundamentals of range trading, you can make some serious money trading ranges effectively.

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Disclaimer:

The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.

This post was written by Graeme Watkins

CEO Valutrades Limited, Graeme Watkins is an FX and CFD market veteran with more than 10 years experience. Key roles include management, senior systems and controls, sales, project management and operations. Graeme has help significant roles for both brokerages and technology platforms.

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