While you may want to trade with the trend most of the time, sometimes there is an opportunity to make money from range trading markets that is markets where the price is moving sideways between limited price levels. If you look for the correct opportunity, this can be as safe as trading with the trend.
If you think you have a range trading market that you would like to trade, then your first task must be to identify the range of prices that the security is trading within. This involves determining a support level, that is a price which the security touches but doesn’t go down through, and a resistance level which is similarly a price above the trading range which the price does not pass up through. You should look for the price to touch the support and resistance at least a couple of times, as this gives you some confidence that the levels are going to remain. The more these levels are touched and the price is rebuffed, the more you can trust them to perform well in the future.
The process of making a profit from the range trading market is then simply to buy at the support level and sell at the resistance. You can also sell short at the resistance and buy to cover when the price drops to the support. At least, that is the principle that you’re trying to apply. One point you should always watch for is that the price may ‘break out’ from the range, and you need to protect yourself from any losses being too great if this happens. If you watch the volume of trading, and look at the oscillators for signs of an overbought or oversold market, then you may be able to spot the warning signals for a breakout that would keep you out of the trade and perhaps allow you to plan a trade in the opposite direction.
What some people will do is let the price touch the support or resistance line, then place a buy stop order (or sell stop order) just away from the line so that it is triggered as the price starts coming back. This provides some protection against the price continuing its run right through the line, making a breakout.
As always when you place a new trade, you should set a stop loss order to prevent an adverse trade from affecting you too badly. In this case, the level is easy to see. You set your stop loss just outside the support or resistance level so that a failure of it to hold as you expect would immediately take you out of the trade for a small loss.
An avenue is to short-sell financial instruments that are range-bounding. For instance lately whenever the Dow Jones has moved over the 10,600 level it has retraced back so a possibility would be to short the Dow at say, 10,650 with a stop at the 10,800 level (150 risk points). Here a trader would target to open his short position near the top of the range using a tight stop loss and he would try to buy near the bottom levels. The Dow Jones index has tended to find support around the 10,000 mark in the past so one would look for a maximum gain of 650 points on each side of the trade.
It can be very satisfying to make a profit in a range trading market, especially if you take a long position when the prices rising and follow it with a short position for coming back down. Despite the fact that the price has gone nowhere, you will be netting a good profit for the time that it remains within the range. The advantage of range trading is that you can use a very tight stop since you know exactly the support level which greatly improves the risk-reward potential and one winning trade will cover a number of losing ones.
