Sick of getting stopped out of trade by markets that can’t decide where they’re going?
Here’s all the tools you need to spot a range-bound market AND to turn it into a profit opportunity …
Early warning sign 1: MACD histogram size
A couple of weeks ago we looked at the Alligator indicator for judging when a market is trending/ranging. Today I’m going to look at a similar technique using the MACD, which takes a bit more getting used to, but I actually prefer.
The most fundamental way to judge how strong a trend is, would be to see how steep the moving average is … and a good measure change in a moving average is the MACD. And specifically, the size of the histogram, gives us a good indication of how forcefully prices are moving.
If the bars of the histogram are small, then the market is more likely to be moving sideways. If the bars are large, then it’s more likely to be moving away from a range, or trending.
In the image below, I’ve drawn a ‘band’ around the histogram, which helps measure when the size of the bars increases …
The problem with this method is judging what size of histogram bar equals ‘range-bound’ and what size equals ‘trending’ – it’s very specific to the market, so I’d recommend looking at past price behaviour, and using that to judge what constitutes a trending bar, and what constitutes a range-bound one.
Early warning sign 2: Hugging the moving averages
The second sideways-spotting trick goes back to looking at moving averages for a warning sign that we’re hitting a range. For this, we’ll put two MAs onto the chart. I’m using a 30SMA and a 5SMA here, and I’m looking for moments when a single candlestick (wicks included) spans both moving averages …
This little warning light can tell us that it’s time to exit any trend-following trade, and look for range-bound opportunities instead.
Range-bound market technique 1: marking channels
The first thing we want to do when we’re in a trading range is mark the boundaries of that range. This is where we want to sell when the price hits the top of the boundary, and buy when the price hits the bottom of the boundary.
Range-bound trades won’t have the ambitious profit targets that trend trades have, but what they lack there, they can make up for in clear boundaries for taking profits or accepting losses.
Drawing your own channels on a price chart can take a little practice, but there are technical tools that can do the work for you.
There are a couple of types of channel that we can look at … dynamic ones and fixed ones. A fixed channel can be drawn as a straight line on your chart and won’t move, while a dynamic one will jump around with price action. Here are some examples …
a. Recent highs and lows
b. Fibonacci levels
Most trading platforms will draw on your Fibonacci levels from a recent high and low range to give you key levels to watch for in a range-bound situation …
c. Donchian channel
The Donchian channel can be useful if you’re not confident drawing in recent high/lows, as it’s simply a measure of the highest and lowest point reached in the last 20 candles (or whatever setting for the number of candles you use). It looks like this …
d. Bollinger bands
Bollinger bands are another dynamic channel that will give you a channel based around moving averages and volatility.
Range-bound market technique 2: overbought/oversold signals
Overbought and oversold signals on our oscillators can be unreliable in a trending market, but in sideways markets, they come into their own. What we’re looking for is a combination of the price hitting the top of our channel, and an ‘overbought’ signal, or the price hitting the bottom of our channel, combined with an ‘oversold’ signal.
Here is an example using Stochastics to judge whether we get into a trade as the price nears the upper and lower boundaries of our channel …
If the price is nudging the top of our channel, and the Stochastics level is above 80 (overbought), then we can have a sell signal. If the price is nudging the bottom of our channel, and the Stochastic reading is below 20 (oversold), then we have buy signal.
Below is another example, this time using 65 and 35 readings on the RSI indicator as ‘overbought’ and ‘oversold’ triggers …
Putting it together
Now that you have the basic tools for spotting range-bound markets, and picking profits off … you come to the most important part – putting it all together in a way that’ll make money.
This is about finding the best entry point for these trades, judging whether there is enough profit in it (this is an important factor in tight ranges, where sometimes the number of pips profit available just doesn’t justify the cost/risk), and knowing where to take that profit.
Much more coming on all these points very soon.
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