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.

In this lesson, we’ll look at characteristics of range trading, as well as the pros and cons.

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?

• 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.

• 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.

• Implement risk management measures. All trading involves risk. 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. Even with stops placed further away, slippage can always occur. Slippage is when the market moves against your trade and, in the time it takes for your broker to process the order, the original price set is no longer available. Guaranteed stops are a way to avoid losses that result from slippage, but remember that those stops are executed at a fee. 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.

Because you’re a responsible trader, you set a stop-loss order slightly below the support level, around 6,980 points. You know this will limit your potential losses if the price breaks below the range. You also set a take-profit order near the resistance level, around 7,180 points, to lock in profits if the price reaches the upper boundary of the range.

Pros and cons of range trading

New traders might ignore range trading because ranges seem limited by how much a price is likely to go up or down before returning to its historical average (as opposed to a trend, which might see much bigger price action). However, the advantage of trading in a range is that it comes with clear risk management.

If the range breaks and you're on the wrong side of the move, you can quickly exit knowing that the market is changing. You don't have to keep second-guessing yourself because the market condition you were betting on, a range, turned out to be wrong.

Advantages:

• Easily defined entry and exit points: Range trading provides clear entry and exit points based on support and resistance levels, making it simpler for traders to plan their trades.

• Manageable risk: Because traders aim to buy at the lower end of the range and sell at the upper end, they can set tight stop-loss orders within the range, thus limiting their potential losses.

• Predictable price movements: In a ranging market, prices tend to move within a relatively stable range, allowing traders to anticipate price movements and make informed trading decisions.

• Multiple opportunities to trade: Range trading works well in markets that are consolidating or moving sideways, providing opportunities for profit even when there is not much volatility or a clear trend. Plus, the back-and-forth price movement within a range means there are likely several trading opportunities available.

Disadvantages:

• Limited profit potential: Compared to trending markets, ranges generally offer lower profit potential because the price movements are smaller.

• Not suitable for volatile market conditions: Range trading may not be suitable in strongly trending markets where prices are consistently moving in one direction, as traders may find it challenging to identify clear support and resistance levels. Traders also need to be patient as they need to wait for price to reach support or resistance levels before entering a trade. This can result in missed opportunities during fast-moving markets.

• Vulnerable to fake outs and whipsaws: Ranges can be short-lived and traders must therefore be cautious of false breakouts, which can trigger stop-loss orders before the price reverts to the range. A sudden shift in market sentiment can also expose traders to whipsaws.