Amongst traders, the market condition that is, oftentimes, most neglected just so happens to be the condition that can seem to be most prevalent.
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While the big, trending moves that could potentially produce a thousand pips seem attractive – those moves are few and far between. And when the trader does catch one of these types of moves, the odds of being able to open it at the exact bottom and close at the exact top, is extremely small.
We’ve all been stopped out of a trade in a clean, trending move. Sometimes by simple oscillation or ‘market noise,’ others by an actual reversal that wipes out most or all of our accumulated profit.
This is where Range Trading can come into play.
As a trader traverses markets long enough to develop their own unique style, most will notice an element of “Range-Trading,’ enter into their approach. Even if the trader is a trend or breakout trader – buying at support – or perhaps buying after heavy resistance is broken – both elements of ‘Range-Trading,’ can only enhance the traders overall arsenal for attacking the financial markets.
But first things first…. Before we get to an actual strategy for trading range, lets establish a couple of points:
1. You can’t predict the future, and likely never will be able to. It’s ok though, because neither can myself or any other trader in the world, and we still manage to get the results that keep us coming back to our charts day after day. Many prognosticators attempt to give the impression that they know what is going to happen in regards to price…. As if they had a secret conversation with EUR/USD last night and euro told them it was feeling jumpy and it was time to make its next move.
Sorry, that just doesn’t happen. Nobody knows what the next move will be, which leads us to #2.
2. As a trader, the only factors that we have in our control are ourselves… Our trade, risk, and money management. While I may not be able to predict what the next hourly bar on EUR/USD is going to do, I can appropriate my trade so that if the worst case scenario takes place, it doesn’t affect me too egregiously. And on the opposite side of that, when I do catch a move, I can manage my trade in an attempt to grasp every single piece of profit I can. My goal is to cut my losers short, and let my winners run … and this is where Range-Trading can help.
After we’ve decided that we want to attack these market conditions, we have to decide on the way of doing so. There are numerous range-trading strategies out there, and quite a few different indicators that can fit the bill.
The strategy that I use to trade ranges is a strategy that I call 13×2. It’s a rather simple strategy that consists of 2 indicators, but at the heart – is really just an opportunity for me to allow my money and risk management to do their respective jobs.
The first indicator in 13×2 is ADX, or the Average Directional Index. This is an indicator that measures trend strength, without any regards to the direction of the trend. ADX will only tell the trader how strong a trend is, not any element of direction or bias.
The cutoff that I use for ADX is 35. If ADX is greater than 35, I simply switch to another currency pair. That’s one of the great parts about the FX Market, the abundance of choices.
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Once I’ve found a currency pair with ADX below 35, I can look for my entry trigger.
The entry trigger that I use for 13×2 is the Commodity Channel Index with; you guessed it, 13 periods. The Commodity Channel Index is an oscillator that’s similar to RSI in function, in that it helps show the trader overbought/oversold levels. CCI is commonly plotted with a line and 3 intervals taking place at -100, 0, and +100. I’m looking for a cross down and through +100 for Short positions, and I’m looking for a cross up and over -100 for Buy trades.
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Now that we know the two components of 13×2, lets look at putting them together in a workable format. Below is a chart with both ADX, and CCI plotted at 13 periods. Each potential entry is numbered below.
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The first Short signal (marked 1 above) is initiated with the CCI cross down and under +100, while ADX is less than 35. Notice that ADX stays below 35 for an extended period – indicating that the trend (if any at all) has been rather weak, and the chart may be conducive for additional range trades.
Shortly after a decline in price following the potential short entry, we have two Long signals shortly thereafter as CCI crosses up and over -100 (The two long entries are marked 2, and 3 respectively on the above chart).
After trade 3 (The second Long entry above), price goes on an extended Bullish run, and ADX correspondingly shows that the trend is strong. ADX veers above 35, thus negating any entry signals that CCI may be showing. Notice that signals 4, 5, and 6 (showing in the CCI indicator) all take place while ADX is above 35. Because of this, I would not look to place any trades based on these signals.
Eventually ADX settles back below 35, and we get another short entry with signal number 7 with CCI going back below +100. Signal number 8 takes place shortly thereafter (shown in green above) as CCI rises above -100.
As I mentioned earlier, risk management is as, if not more important to me than the entry into the trade. With 13×2, I have the added benefit of being able to use market support and/or resistance to place my stops. Once again, this is my line in the sand; the point at which I can definitely say – ‘If this price is hit – my trade idea was incorrect.’ I want to lose as little as possible on this idea and move on to greener pastures that might be more profitable.
Notice the entry signals on the above chart, and the fact that each takes place around a short-term reversal in the market. Many traders consider these moves to be ‘swings.’ Below I’ve diagramed entry 1 and entry 3 in slightly more detail:
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With each entry that I take from the 13×2 system, I have to keep in mind that any entry – regardless of how strongly I feel about it – can move against me and become costly. When I take Long positions, I want to find the Short-term Low (also called the ‘Swing Low’) and use that as my ‘line in the sand.’ If price breaks that swing low and continues moving lower – I have no business being in a long position. Even if the trade can come back in profit for me, I’d rather take my chances with another trade idea on another currency pair.
And the same holds true for Short positions. If I’m establishing a Sell position, I want to find the short-term ‘Swing High’ and use that as my ‘line in the sand.’ When and if that level is hit, I do not want to be in a short trade. That is why I use ‘Swing-Highs,’ and ‘Swing-Lows,’ for my risk management – in the hope of ensuring that I’m not in a long-term losing position that continues to bleed my account.
The one thing we know in trading is that the market is always right. Trading opportunities are abundant, and constant – while our risk capital is not.
Written by Dailyfx.com
