3 Signs a Trading Range is Ready to Break

[RichardCox 10]

3 Signs a Trading Range is Ready to Break

 

Range trading is one of the easiest and most effective technical analysis strategies, given the ease with which sideways ranges can be identified. Another advantage with this approach is the fact that stop loss levels and profit targets are not difficult to place. We simply buy when prices fall toward support (with stop losses just below the range support), and take profits once prices rise back toward range resistance. For short positions, we sell at the upper end range resistance (with stop losses just above that resistance), and take profits once prices fall back toward support. Trading ranges are a fairly common feature of market activity, so it does not take much time to find new trading opportunities.

 

But the biggest risk for these types of trades can be seen when those ranges break, as this will cause your stop loss to be hit. So, it is important to find ways to identify these potential risks as a means for protecting your positions. Here, we will look at three tell-tale signs that a trading range is ready to break and start trending in a new direction. An added benefit of these events can be seen when new trending (breakout) positions are established in their early phases. But even if breakout strategies are not your cup of tea, these signals can still prove highly valuable when you are exposed to positions that benefit from sideways movements.

 

Changing Price Conditions

 

One of the only certainties in the market is that prices cannot continue on one direction forever. Change is a helpful and essential aspect of the market environment, but when we are caught off-guard, losses start to accumulate. There are many ways to spot trend breakouts (a changing range bound environment), and it is important to act on these signals once they develop. This is true not only for those looking to establish new positions in the upcoming trend, but for those in positions that are based on the range scenario that is about to be invalidated.

 

To achieve this, we must note some of the common price traits that are seen when prices are ready to explode into a new bull or bear trend. An understanding of these traits will allow you to get in “on the ground floor” of the next trending move, or at least to avoid range trades that have a better chance of being stopped for a loss. In this article, we will look at three of these traits. To be sure, more than three exist but once these market events are seen they can prove highly effective in signaling significant market changes.

 

Common Breakout Precursors

 

Chart scenarios suggesting prices are trading water should be viewed with skepticism if any or all of the following elements are true:

 

● Prices are consolidating sideways after a significant trending move has occurred

● Sentiment readings become highly unbalanced and oppose the previous trend

● Oscillator readings are consolidating

 

 

Consolidating Prices After Impulsive Activity

 

When we use the word consolidation, we essentially mean that prices are trading in constricting ranges. Use of the Average True Range (ATR) indicator is one way of seeing this, and if we see declines in the reading we would see an indication of increased consolidation. Chart patterns offer other ways of seeing this activity. For example, in the first charted illustration we can see a symmetrical triangle (a common consolidation pattern), with prices trading in smaller and smaller ranges. But since this activity cannot continue forever, upside breaks out of these triangles should be thought of as a “buy” signal, while a downside break would indicate that sell positions should be taken.

 

Of course, consolidation patterns do not need to be symmetrical, and other examples include wedges and coil patterns that are marked by higher lows and lower highs. For these patterns, the most interesting area is the apex, as the smaller spaces make it much more likely that prices will break outside the pattern, and send the next trending signal. When prices constrict into consolidation patterns, buy orders can be placed above the structure and sell orders can be placed below. This is done in anticipation of the explosive move that is likely to follow. These patterns can lead to even more extreme moves when they follow a big trending move, creating a “Flag” structure. In these cases, a single entry order can be placed in the direction of the previous trend.

 

Sentiment Indicators Reach Extremes

 

An alternative approach can be used when we look at sentiment indicators, which show the type (buy or sell) and number of open positions in your chosen currency pair. One of the most commonly used readings is the Commitments of Traders (COT) report, which is released every Friday. Essentially, this tells us where the majority of traders have based their positions. So, for example if we see most of the market positioned long in a bullish environment, there is real danger that uptrend will reverse because there is nobody left to buy the asset. An event like this can lead to stalling, where ranges form and prices constrict. Once the majority loses hope and starts to close positions, major reversals can follow, breaking prices out of the previous range. For these reasons, it is important to have an idea of where market sentiment rests before establishing new positions. The best opportunities are usually seen when more than two-thirds of the market is positioned on one side, as this creates strong potential for sharp reversals.

 

Consolidating Oscillator Readings

 

Oscillators can be useful in spotting potential breakouts as well. Tools such as the MACD, which lets us see instances where price and momentum are in agreement or diverging. But what many traders miss is that the indicator readings themselves can show consolidation scenarios, which can signal major breakouts are coming down the pipe. Similar moves can be seen when price and momentum show divergences, as there is little reason to believe that the moves currently seen can sustain themselves. Here, we will look at Oscillator consolidation, which bears resemblance with price consolidation.

 

In the next charted example, we can see that movement in the MACD is constricting near the zero line, indicating a period of indecision and tighter trading ranges. In this example, we can see a symmetrical triangle as formed as movement in the MACD constricts, but price patterns could also be seen as wedges or rectangular trading ranges as well. Price breaks above the symmetrical just as the MACD reading starts to move into positive territory, and this would be our initial signal that a major bullish trend is beginning. So, in a case like this, we would not want to look to simply buy at support and sell at resistance because there are simply too many signals that a big trending move will be seen. In this example, signals are sent from both the MACD and the price itself, so if we were also to see an unbalanced sentiment reading (in this case, a majority of traders positioned short), all three elements would be in place and high probability long positions should be initiated.

 

Conclusion: Avoid Range Trading When Evidence of a Breakout is Apparent

 

These three market elements give traders important clues with respect to the types of trading strategies that should be implemented. When there is mounting evidence which suggests that constricting price activity is coming to an end, traders can expect big breakouts. This means that range trading strategies should be avoided in favor of breakout orders positioned above or below the consolidation pattern.