Range trading can be a very minimal risk way to trade stocks if you have found a stock with strong support and resistance. To deploy range trading as a strategy, you must have basic understanding of technical analysis and the indicators described in my previous article on the subject. Once you know the basics, you will be able to find better opportunities in the market.
Let’s go over a few examples of range trading:
Here is a chart of New York & Company, a clothing retail chain. As you can see, the chart has well defined support and resistance areas. Once you find a chart that has stable support and resistance, you will be able to use range trading.
In mid-May, the stock was in a downtrend and looking to be heading to support. Soon, the price action bounces off support, giving a short term rally until end of June. When you see the price action bounce off support like that in May it is a possible buying opportunity. However, expect the move to be very short term.
Once the short term rally was over, the stock once again fell to support, but this time it breaks support. Now, we will be able to tell if the stock is breaking down or if this support line is strong. As it turns out, the price bounced back up above the support, confirming the support, before heading straight to resistance. I highlight this area of the graph because once you see that support line being confirmed, expect a nice run up in the price, this is a buying opportunity. Shortly after the price shot up to resistance, we see two down days as the price was fighting resistance. If after three trading days, the price action fails to break and close above the resistance, it’s a short sell candidate.
As you can see, there are signals that the chart gives you that tells you what will happen next, all you have to do is recognize them when they show themselves. Once you can recognize the signals, range trading can be a very lucrative strategy that beats buy and hold.
However, there are some risks involved in this strategy. For instance, confirmed breakouts do happen from time to time and if you are ill-prepared, you could be looking at significant losses. Here is an example of the potential risk:
As you see, this is a chart of the iShares Barclays Government/Credit Bond ETF. Starting at the left of the chart, we see that the ETF originally was in a strong range (perfect type of environment to deploy range trading strategy). However, as the rising wedge grew, the ETF did breakout at one point. As you can see, the resistance proved to be reconfirmed and the price fell drastically. The risk here is that even though the ETF broke out upward initially, the fundamentals went against the trade causing the stock to fall below support.
It is important to search recent news to determine the sentiment behind what you are trading. Fundamentals should be a part of your research along with technicals. If you had kept up with the news, you would have known that government bonds were falling. At the very least, once you see the stock stuck above resistance like that, it is an indicator that resistance is strong. This would be a possible time to get out of your long position and opening a short position.
The bottom line here is range trading can be a very successful strategy to use. Be sure you understand the basics, as they can help you see the trend turning before it happens. Breakouts can hurt if you are on the wrong side of the trade, so be sure to watch your indicators for any potential turn in the trend.