Identifying ranges in trading

Unlike trend following, traders will go both long and short when trading ranges, at different times, depending on the position of the price within the range. This contrasts with trading trends, where traders will go with the overall direction of the trend.

You can use several methods to identify support and resistance levels in range trading. Let’s look at some of the most common ones.

How to identify ranges

Before you can trade a range, you need to identify it. That’s done by looking at historical price data, which is why technical analysis is so important in this type of trading strategy. You can take the simple approach of basing your range trading strategy solely on identifying support and resistance levels on a price chart and then using them to decide when to open positions. Usually, a price must recover from a support area at least twice and also move back from a resistance zone at least twice. Otherwise, the price may simply be establishing a higher low and higher high in an uptrend or a lower high and lower low in a downtrend.

Some traders will use technical indicators to confirm a range or provide buy and sell signals by pointing out when assets are overbought or oversold. Some of the most common tools used by range traders include pivot points and volatility or momentum indicators.

Pivot points

Pivot points are areas at which the direction of price movement might change. They are calculated based on previous day's high, low, and close prices. Range-bound traders use pivot points to identify where they can place their buy or sell orders. Usually, pivot points are calculated using the same method (the five-point system):

Pivot point (P) = (previous high + previous low + previous close) / 3

Support 1 (S1) = (pivot point x 2) - previous high

Support 2 (S2) = pivot point - (previous high — previous low)

Resistance 1 (R1) = (pivot point x 2) — previous low

Resistance 2 (R2) = pivot point + (previous high — previous low)

For example, if you were trading the USD/CAD forex pair, and the previous day's high was 1.3050, the low was 1.3000, and the close was 1.3025, the pivot point would be (1.3050 + 1.3000 + 1.3025) / 3 = 1.3025.

You would then calculate your support and resistance levels as follows:

S1 = (1.3025 x 2) – 1.3050 = 1.3

S2 = 1.3025 – (1.3050 – 1.3000) = 1.2975

R1 = (1.3025 x 2) – 1.3000 = 1.3050

R2 = 1.3025 + (1.3050 – 1.3000) = 1.3075

Did you know?

Pivot points can be added on to a chart in the IG platform (including in the demo account) by selecting the indicator drop down menu and choosing ‘pivot points’ or by right-clicking to select them, meaning you don’t have to manually do these calculations. It’s as easy as the click of a button. You can also add pivot points on different timeframes.

Technical indicators

The average directional index (ADX) is a technical indicator typically used to measure the strength of a trend. But, when it comes to trading ranges, it can also be used to confirm range-bound conditions by indicating low volatility. Low ADX readings suggest a lack of strong trend, which can help to confirm a range-bound market environment. ADX plots values from 0 to 100, with higher values showing more robust trends. Many traders will take a reading of below 25 to confirm a range-bound market. Read more about ADX and how to use it with different trading strategies here.

Range traders may combine the ADX with other indicators to further confirm range-bound conditions. For example, if the ADX indicates low volatility while the relative strength index (RSI) shows overbought or oversold conditions within the range, it may provide additional confirmation for potential range reversals.

Did you know?

The RSI is a technical analysis tool that assesses the momentum of assets. Traders use it to gauge how quickly prices are moving in one direction and gives a number between 0 and 100. Generally, readings above 70 indicate overbought conditions and readings below 30 indicate oversold conditions.

Another technical indicator that can be used is the commodity channel index (CCI). Although it’s not specifically for range trading, traders can use it for identifying overbought and oversold conditions, confirming range-bound conditions, and timing trades within trading ranges.

The CCI is a technical indicator used to measure the current price level relative to an average price level over a specified period of time. Like the RSI, it’s an oscillator indicator (tools that show oscillations or fluctuations above and below a centreline, usually indicating overbought or oversold conditions).

The CCI oscillates around a zero line. Positive values indicate that the price is above the average and negative values indicate that it’s below the average. Traders can use extreme CCI readings to identify overbought or oversold conditions within a range. For example, if the CCI reaches a high positive value (e.g., above +100), it may indicate that the price is overbought and could potentially reverse downwards, signalling a sell opportunity within the range. Conversely, if the CCI reaches a low negative value (e.g., below -100), it may indicate that the price is oversold and could potentially reverse upwards, signalling a buy opportunity within the range.

Traders might also use the CCI to identify range boundaries. When the CCI oscillates between positive and negative values around the zero line, it suggests that the price is trading within a range. Traders can look for opportunities to buy near the lower boundary of the range when the CCI reaches oversold levels and sell near the upper boundary of the range when the CCI reaches overbought levels.

Try identifying ranges yourself

In your demo account, choose a currency pair with a history of exhibiting range-bound behaviour, such as EUR/USD or GBP/JPY.
Observe historical price data and identify periods where the price has been trading within a defined range, characterised by relatively consistent highs and lows.
Draw support and resistance levels based on the identified price ranges.
Add pivot points to the daily chart to help you to identify potential reversal or breakout levels.
Look for RSI readings above 70 and below 30, as well as CCI readings above +100 and below -100 to help identify potential overbought or oversold conditions (which can assist you with setting entry and exit points within the range).
Plan your trade, including entry and exit points, stop-loss orders and limits.
Execute your simulated trade.
Analyse your trade and capture lessons in your trade journal.
Focus on whether your trading plan effectively capitalised on the range-bound price movement and whether any adjustments to the plan are necessary for future trades.
Rinse and repeat.