Trading Ranges

A trading range is a horizontal corridor that contains price fluctuations for an extended period. Generally speaking, markets tend to spend most of their time in trading ranges. Unfortunately, however, trading ranges are very difficult to trade profitably. In fact, most technical traders will probably find that the best strategy they can employ for trading ranges is to minimize their participation in such markets, which is easier said than done. While there are methodologies that can be profitable in trading ranges, the problem is that these same approaches won't work in trending markets. Also, while trading ranges are easily identifiable for the past, they are nearly impossible to predict. Also, trading ranges can often last for years.

Once a trading range is established, the upper and lower boundaries tend to define support and resistance areas. Breakouts from trading ranges can provide important trading signals. A breakout from a trading range suggests an impending price move in the direction of the breakout. The significance and reliability of a breakout are often enhanced by the following factors.

1. Duration of the Trading Range. The longer the duration of a trading range, the more potentially significant the eventual breakout.
2. Narrowness of Range. Breakouts from narrow ranges tend to provide particularly reliable trade signals. Also, such trades can be especially attractive since the meaningful stop point implies a relatively low dollar risk.
3. Confirmation of Breakout. It is rather common for prices to break out from a trading range by only a small amount, or for only a few days, and then fall back into the range. One reason for this is that stop orders are frequently clustered in the region beyond a trading range. Consequently, a move slightly beyond the range can sometimes trigger a string of stops. Once this initial flurry of orders is filled, the breakout will fail unless there are solid fundamental reasons and underlying buying (or overhead selling in the case of a downside breakout) to sustain the trend.

The very nature of a market is to be in constant search of price equilibrium, and trading ranges signify that a market has, indeed, found an equilibrium between the two price levels. Thus, markets will tend to stay in that range until some outside force is strong enough to push it out. Since the function of the market is to always ensure that it is at an acceptable price level, if it gets pushed out of its comfort zone (the trading range), it will usually attempt to react back to its breakout point just to make sure that indeed it must now enter into a trending pattern. If the market comes back into the trading range for any significant length of time, it would indicate a false breakout.

Figure 6 below represents the weekly Sugar chart which held a trading range from mid 1995 through 1997. The initial breakout to the downside was quickly followed by a rally back up to test the bottom of the trading range before continuing on down in its new direction.