What is range trading

Range trading involves identifying a price range within which a financial asset is trading, then buying at the lower end of the range and selling at the upper end of the range. Traders using this strategy typically look for assets that have established clear support and resistance levels, creating what’s called a “range-bound pattern”.

One of the markers of range trading is the absence of a strong trend. This creates opportunities for traders to buy low and sell high or sell high and buy low within the range. While range trading conditions might not seem as exciting as “eventful” or volatile market trading conditions, more defined risk management is one of the many benefits of range trading.

Characteristics of range trading

Range-bound markets are characterised by sideways price movements where no new highs or new lows are coming into play. You’ll often hear the term “mean reversion” associated with range trading. Another way of saying mean reversion is “return to average price”, which is a market’s tendency to default to the average price following a large move.

Range trading strategies are based on the belief that prices will return to a historical average. This is the opposite of breakout trading, where traders try to capitalise on moments of increased volatility and directional movement that might continue for a while in the same direction, potentially leading to bigger gains.

Range trading strategies can be applied in various financial markets, including forex, stocks, commodities, indices, cryptocurrencies and futures, among others. Whatever the market, range trading strategies will only be effective where there is sideways movement (also known as ranging or consolidation). Range trading is sometimes considered a short- to medium-term trading strategy. However, trading ranges can be seen in all time frames, from short-term five-minute charts to long-term daily and monthly charts.

How do I implement a range trading strategy?

1. Find a range. The starting point for implementing a range trading strategy is to identify a range. Traders do this by analysing historical price data to identify levels of support (lower boundary) and resistance (upper boundary) within which the price tends to fluctuate. Usually, a price should 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.

2. Buy at support and sell at resistance. To trade a range, you would buy an asset when the price reaches the support level, anticipating a bounce back up within the range, and then sell when the price reaches the resistance level, expecting a pullback. As with any new strategy you’re testing out, it’s wise to experiment first in a demo account, where there’s no real money at stake.

3. Implement risk management measures. All trading involves risk, which is why savvy traders set stop-losses and limits, ensuring they minimise any potential losses if the price breaks out of the established range. In fact, because range trading is popular, traders might be attracted to a particular ranging market, which can increase volatility. To manage their risk, prudent traders will therefore look to use “wider” stops around the key levels. It’s a balancing game, however. If the range is too tight, then the stops at the required distance may not create the necessary risk-reward ratio to provide an attractive rationale for a trade.

While trading ranges offers easily defined entry and exit points, profit potential is limited by the size of price movements. As with all trading strategies, it’s critical to manage your risk. Range traders should be aware of the risk of potential false breakouts or whipsaws.