"A ranging market is a term given to a market condition where price typically does nothing, but drift. This phase is also known as the accumulation phase. In this phase, price tends to build up momentum. In other terms it is also known as a period where institutional players are buying and selling and building up positions in the markets. Typically, after a sideways range you can expect to see a breakout in the markets. The direction of the breakout can be different. Sometimes, the breakout occurs in the direction of the previous trend, or at times, the breakout can occur in the opposite direction. No matter what, sideways markets are often seen as a period where traders can quickly trade or traders prefer to wait on the sidelines until a trend emerges. In this article, we looking what are sideways markets and how they work. We also give you tips on using technical indicators to identify when the markets are moving sideways."
Range bound markets is a term that you might have come across if you have been trading for a while. It goes by different names including sideways markets or zig zag markets. No matter what name it is called by, range bound markets is a phase where the price moves as described; moves within a range.
There are some distinct advantages and disadvantages of a range bound market. Obviously, you might have guessed by now that the range bound market indicates that the market is trading in a range. There is no trend, period.
Some traders have used the range bound markets to make profits. This happens by simply buying and selling when the price reaches the upper end or the lower end of the range. This sideways corridor offers some short term trading opportunities.
Depending on how wide the range is, you can expect to make equivalent profits accordingly. But it is not as simple as it sounds. Sometimes range bound markets can also trick the traders. But by and large, the general prevailing factor is that traders use such market conditions to make short term profits.
Typically, they make use of technical indicators such as oscillators that can help them to identify overbought or oversold levels. But does this mean trading sideways markets are all about buying when the indicator moves into either the overbought or oversold levels? Not exactly!
Why do markets move in a sideways range?
A sideways range is also known as an accumulation phase. This is when price is confined to a range as it continues to build up momentum. Think about the sideways market as a rocket booster which initially ignites for a while before allowing the rocket to take off.
The build up of momentum during the ignition phase eventually pushes the rocket higher. The same concept applies in the forex markets as well. When price settles in a range or in an accumulation phase, you can expect price to breakout from the range sooner than later.
Depending on the momentum that is built, the level of breakout can be significant. Typically, range bound markets happen after a strong trend or just before a strong trend.
Example of range bound markets
In the above chart, you can see the illustration of the range bound market. The rectangular areas are where the ranging or accumulation phase occurs. Following this, you can see how the markets breakout into a strong trend.
This is later followed by price reaching a new high only to retreat slightly and enter into a range again. Once again you can see a strong breakout to the upside.
This type of ranging markets tends to occur every now and then.
How to identify range bound markets?
While on one hand there is no way to predict a range bound market, fortunately, there are technical indicators that you can use which will identify these markets for you. Examples of some technical indicators that you can use are:
- Bollinger bands
- Technical chart patterns
Bollinger bands are also known as volatility bands. These bands based on the 20-period moving average and a two period standard deviation will contract and expand as and when the volatility rises and falls.
Thus, when the bands contract, you can expect the volatility to fall suggesting that the markets are in a range. Likewise, when the bands expand, you can see that the volatility is rising indicating a move from the range bound markets to trending markets.
Ranging markets via Bollinger band volatility
The above picture is the same as the previous one. The only difference here is that we added the Bollinger bands. You can see that in the areas that we previously highlighted as ranging markets, the bands contract.
When the markets start to trend, you can see the bands expanding. This is nothing but the ranging or the sideways market in action.
Besides technical indicators, you can also use technical chart patterns such as the flag or pennant patterns. These patterns are recurring and indicator a potential breakout after price moves into a consolidation phase in the near term.
You can also use oscillators that identify overbought and oversold levels to trade the ranging markets. It is entirely a matter of personal choice on how you wish to trade the sideways markets.
But bear in mind that the risks of being stopped out are much higher in a ranging market compared to a trending market. Therefore, traders need to be adept with such conditions and be quick to react to the price action.