How to identify range-bound markets?

Identifying trends in the stock market is one of the fundamental skills a trader must possess to be successful in stock market trades. Since stocks are subject to constant fluctuations, analysing and trading according to the trend is the only way to bring some structure to trading. 

There are various kinds of trends, such as uptrends, downtrends, range-bound trends, etc. In today’s article, let us understand what the market looks like in a range-bound trend and how to identify such range-bound markets.

What is a range-bound market?

A range-bound market is where the stock’s prices trade within a particular range. It is where stocks trade in between the previous highs and lows. Since both bulls and bears fail to dominate the market, neither a new high nor a new low is created. It is a situation where the stock’s prices move sideways and fluctuate between the support and resistance levels.

• Support: The lowest price a stock can reach after it bounces upwards.
• Resistance: The highest price a stock reaches before falling downwards.

When the market starts getting dominated by bulls or bears, the stock prices break out of support or resistance levels to create a new trend. But, in a range-bound market, the absence of strength by bulls or bears causes the stock to trade within the support and resistance levels.

Range-bound market indicators

Identifying a range-bound market is essential to formulate appropriate trading strategies. Various technical indicators suggest how to algorithmically identify range bound market. Some of them are:

• Price channels

Price channels are two parallel lines between which a stock’s price fluctuates. Traders use support and resistance levels to draw these lines. Upon drawing the two lines, traders must observe the price movement of stocks for a specific period. In a range-bound market, the stock price stays between the two lines without a significant breakout.

• Bollinger bands

Bollinger’s band is a chart that is widely used among technical analysts to understand a stock’s volatility. The chart consists of three bands or lines, where the middle band is a simple moving average of the stock’s price observed for 20 days. The upper and lower lines depict standard deviations. While the middle band indicates the direction of the stock, the upper and lower bands indicate the volatility. If the gap between them is wide, the stock is more volatile and vice versa.

In a range-bound market, the stock’s price moves between the upper and lower lines. The gap between them is also narrow, suggesting a sideways market.  

• Relative Strength Index (RSI)

The relative strength index is a tool that suggests the strength of a trend. The RSI value is calculated based on how the stock is trending for 14 days. The RSI value falls between 0 and 100, with 0 indicating a dominant downtrend on all 14 days and 100 indicating an uptrend on all 14 days. 

An RSI under 30 is an indication of an oversold or a bearish market, and above 70 indicates an overbought situation or a bullish market. In a range-bound market, the RSI falls between 30 and 70.

• Average Directional Index (ADX)

ADX is another indicator, like the RSI, that suggests the strength of a trend. It indicates a value between 0 to 100, with 0 showing no strength and 100 showing the maximum strength.

The ADX value can either be positive or negative. When the value is negative, it shows how strong the bearish trend is. When the value is positive, it suggests the power of bullish dominance. Either way, ADX must be above 25 to show a strong trend. 

A value below 25 indicates a weak trend and suggests an indecisive or a range-bound market where prices are moving sideways. 

Strategies to trade a range-bound market

Multiple strategies help traders trade a range-bound market. Range trading is a common strategy for traders trading within a range. They sometimes use bounce strategies, where they take entry and exit positions closer to the upper and lower range to make profits when the price bounces back. Another common strategy is break out, where they take positions when there is a break out from support or resistance, to benefit from the upcoming trend.

Traders also use options strategies for a range-bound market, such as straddle, strangle or iron condor, where they enter multiple options contracts to cover themselves for movements in either direction.

Bottomline

A range-bound market is where stock prices move within specific price limits. It is where stock prices do not break the support or resistance levels to create new highs or lows.

A range-bound market occurs when neither bulls nor bears are dominant, and the market is moving sideways. Identifying a range-bound market and the ranges is crucial in formulating strategies to trade with the trend. Traders must use a combination of the indicators available to confirm whether the market is range-bound, before taking positions.

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