When a securities trades between constant high and low values over a period of time, it is called a trading range. Price resistance is commonly found at the top of a security’s trading range, while price support is usually found at the bottom.
When a stock breaks through or falls below its trading range, it typically indicates the development of momentum (either positive or negative). A breakout occurs when a security’s price rises above a trading range, whereas a breakdown occurs when the price falls below a trading range. Breakouts and breakdowns are typically more dependable when they are accompanied by a significant volume, implying broad engagement by traders and investors.
Many investors consider the length of a trading range. Large trending moves frequently follow long range-bound periods. The trading range of the first half-hour of the trading session is widely used as a reference point for intraday tactics by day traders. A trader, for example, could purchase a stock if it breaks over its initial trading range.
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Volatility and ranges
Because price volatility is equated with risk, a security’s trading range is a useful predictor of its relative riskiness.
A cautious investor chooses stocks with fewer price swings over equities with strong gyrations. Such an investor may prefer to invest in more stable sectors like utilities, healthcare, and telecommunications over more cyclical (or high-beta) sectors like financials, technology, and commodities. In general, high-beta sectors may have broader ranges than low-beta sectors.
Trading Range Techniques
A trading method that aims to find and capitalize on equities trading in price channels is known as range-bound trading. A trader can purchase a security at the lower trendline support (bottom of the channel) and sell it at the higher trendline resistance after identifying important support and resistance levels and linking them with horizontal trendlines (top of the channel).
Support and Resistance
If a security is in a well-defined trading range, traders can purchase when the price approaches the support level and sell when it hits the resistance level. When price oscillates within a trading range, technical indicators such as the relative strength index (RSI), stochastic oscillator, and commodity channel index (CCI) can be used to validate overbought and oversold positions.
For example, a trader may start a long position if the price of a stock is trading at support and the RSI is below 30. Alternatively, the trader may elect to start a short position when the RSI rises over 70 and enters the overbought zone. To reduce risk, a stop-loss order should be set just outside of the trading range.
Breakouts and Breakdowns
Traders might enter in the direction of a trading range breakthrough or breakdown. Other signs, such as volume and price movement, should be used to corroborate the move’s validity.
For example, on the initial breakout or breakdown, there should be a considerable rise in volume, as well as multiple closes outside the trading range. Rather than chasing the price, traders should wait for a pullback before placing a trade. A buy limit order, for example, maybe placed right above the top of the trading range, which is now acting as a support level. To safeguard against a failed breakout, a stop-loss order might be placed on the other side of the trading range.
