What is the Range Trading Strategy?

At the core of any online share trading strategy, you are basically adopting one of the following analysis methods: fundamental analysis or technical analysis. When employing a fundamental analysis approach, you delve into a company's financials, industry peers, and overall market structure. Conversely, if you opt for a technical analysis approach, you evaluate a stock's price movements on the charts over a specific timeframe.

In this article, we will look into the range trading strategy that falls into the latter category. We will learn what a trading range is and how you can use this strategy to make money in the stock market. 

What is a Trading Range? 

Range trading is a widely-used trading strategy that focuses on identifying and using distinguishable channels between which the price fluctuates over an extended time period. A channel — or the trading range — is created when the price consistently fluctuates between specific high and low levels. Those high and low levels serve as the support and resistance, which gives rise to the channel. 

The support, which is the lower boundary of the channel, functions as the lower boundary. Likewise, the resistance level serves as the upper boundary or supply zone. Demand zones witness strong buying activity, while supply zones witness strong selling activity. By carefully analysing the price range and observing the price movements within it, range traders can identify potential entry and exit points to maximise their profits.

How the Range Trading Strategy Works?          

The price within a trading range or a channel can give rise to patterns or shapes, such as rectangles, triangles, wedges, etc. What this means is, suppose the resistance and support levels appear as two horizontal lines, then we get a rectangular range. Similarly, the support and resistance lines appear as if they are converging; the price action could look akin to a triangle, resulting in a triangular range. 

The first step of a range trader is to identify the trading range; generally, most range traders prefer rectangular ranges if they plan on trading within the range, which is — range-bound trading. The strategy is based on the assumption that the price will move upward when it approaches the support and reverse downward when it is near the upper boundary of the channel, which is the resistance. 

So, what a range-bound trader basically does is that they buy at/near the support and sell at/near the resistance. 

This strategy involves identifying a well-defined trading range and closely observing the price behaviour within that range. It is essential to ensure that the boundaries of the range are robust support and resistance zones, meaning that the price has rebounded from these levels at least twice in each case. The objective is to ride the upward trend and secure profits as the price approaches the resistance level. 

As the price nears the resistance, the assumption is that it will fall back towards the support level, thus, restarting the cycle and presenting an opportunity to enter another long position. However, It is essential to ensure that the boundaries of the range are robust support and resistance zones, meaning that the price has rebounded from these levels at least twice in each case.

Range Trading Example

Let's take an example to illustrate the range-bound trading strategy. Assume a stock is trading within the range of Rs.300 and Rs.400; Rs.300 acts as the support level and Rs.400 as the resistance level. Since you have established the fact there is a strong support at Rs.300, you may decide to take a long position near that level.

However, it's important to wait for confirmation of the price reversal before entering the trade. This essentially means ensuring that the price is showing signs of moving back up from the support level. Although, by doing this, you may not enter the stock exactly at Rs.300, it is acceptable to enter anywhere near the support level as long as the reversal is confirmed.

Once you have taken a long position, you ride the upward trend and consider booking profits as the price approaches Rs.400. It is not necessary to wait until the price reaches Rs.400 to exit the trade. A price reversal can occur before that level is reached. For instance, you might notice a reversal and the start of a downward trend around Rs.392. Therefore, closely tracking the price movement is crucial once you have entered your position.

Do Trading Ranges Last Forever? 

The range strategy is not foolproof since ranges eventually break; either the support or the resistance will be breached. Meaning you take long positions at the support expecting the price to rise, but the price cuts below the support and further declines. Hence, always ensure you have a stop-loss in place to mitigate losses in the occurrence of an event like this.

On the flip side, you may expect the price to reverse upon nearing the resistance. Instead, what happens is the price cuts above the resistance, giving a breakout and making new highs. Here, if you have completely booked profits you lose out on making more money; however, this is part and parcel of being a range trader. 

Conclusion 

In conclusion, trading ranges may present multiple opportunities to buy at the support and sell at the resistance. Moreover, you can find trading ranges on various timeframes, which makes it suitable for intraday, swing trading, and positional trading strategies. However, don’t ignore the risks; you can even bolster the efficiency of the range trading strategies by using technical indicators like moving averages and the average daily range (ADR). Open a trading account with blinkX app to start trading in the share market.