Essential FX Trading Strategies

RANGES
Trading ranges
Traders can get hung up on trends – the fact is that most of the time market is not in a strong up
or down trend; it is moving sideways (although this is itself a trend of sorts). When markets are
fluctuating up and down with no strong direction, trading the range can be a useful approach,
particularly for intra-day forex traders hoping to profit from short-term volatility in prices.

Traders seek to identify overbought and oversold extremes – resistance and support areas, buying
when the market is oversold and selling when it is overbought.

Ranges, it may be said, are often corrective waves within a stronger trend with the direction of the
price flattening out and holding within a range while the longer term trend pauses for breath.

Alternatively, strong trends can simply run out of steam and prices can start to fade sideways for a
period of time until new information is available to reignite the trend or spark a reversal and a new
trend in the opposite direction.

The basis of trading a range is to identify when prices are reaching an extreme within the range
and are due to reverse course in the other direction. In many ways therefore trading ranges is
about spotting short term trends and reversals.

Many range traders are not fussed about direction – their view is that prices will tend to trade
through a particular level more than once, or multiple times and therefore will seek to profit from
this oscillation around a mean.
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The importance of support and
resistance
The most important aspect of trading ranges is being able to identify the upper and lower price bounds – in other words we need to identify
the range.

We can do this by identifying highs and lows to create support and resistance levels.

For instance, on the below chart we can see a clear trading range for the EURGBP pair from September 2017 to March 2018 with prices
moving within the c87-90 range without any clear evidence of direction.
EURGBP stuck within the 87-90 range

Source: ETX Capital

To identify the range, we can look for multiple touches (at least 2) on the lower and upper bands – the levels of support and resistance. These need not be precise
and may be classed as zones of support and resistance.

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Moving averages and mean
reversion
If one views prices changes as a distribution around their average, then it stands to reason that they will have a tendency to revert to the
mean. Moving averages play an important part in range trading by showing where this mean price is and therefore highlighting how far
price action is moving away from the mean.

The idea of range trading is that when prices do move a long way from their average, there is a solid chance that they will in part at least
try to move back to the average, or mean. If markets are in a strong uptrend, they will tend to be above moving averages; and below if in
a downtrend.
In a sideways market such as this example of gold (below chart), the price action oscillates intermittently either side of the 50-day moving average.

Gold hugging its 50-day moving average

Source: ETX Capital

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Timing
With our range identified, we can start to consider entry and exit points for our trades. The use of indicators and oscillators is important
here. The aim of course is to enter when the market approaches one extreme of the range, and exit once it reaches the other.

Determining when a market is overbought or oversold is clearly very important. Various indicators can be used to help. For instance the
Relative Strength Index and Commodity Channel Index (CCI) are indicators that may be used as these delineate prescribed overbought and
oversold levels.
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Setup
There are different ways to approach a range trade. You can use established levels of support and resistance, incorporate indicators and
oscillators, and/or make use of moving averages. There is no hard and fast rule, but considering the various elements and knowing how
and where to apply each –and when not to – is important.

In a simple range-bound market, the idea would be to place a buy order just on or just above established support, or enter when the price
is considered oversold and is below the moving average. A stop loss order can be placed below the support level or somewhere below the
entry point. The take-profit (limit) sell order can be set on or near the level of established resistance, or near where the moving is.

As ever with trading, having a clear risk to reward ratio in mind is important. Usually traders will look for this to be something like 1:2, or 1:3.
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Managing risk –
spotting breakouts
We have just touched on stops, but these are very important. Breakouts can occur and so a stop can protect your trade from running higher
losses. However, many false breakouts are common in range-bound markets and therefore it is important to pay close attention to how far
your stop is away from the entry point. In this regard, the importance of thinking about support and resistance as zones rather than precise
price points is useful as it can allow for many false moves.

By the very nature of range trading, you are at risk of a breakout leading to losses. Looking for breakout patterns on price charts plays an
important part, while indicators and oscillators will also help identify when a breakout might happen. For example, when Bollinger Bands
narrow it is usually a sign of a very sharp price move – something that you should beware when trading a relatively narrow range.
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Useful indicators
Moving averages
Moving averages are helpful in determining whether the market in a strong uptrend, strong down trend or is range bound. A market that
is consistently above its n-period moving average is considered in an uptrend and therefore not suitable for range techniques. Likewise
one that tracks below its moving average is in a downtrend and not in a range. Moving averages are also helpful in showing where the
mean lies for prices.

ADX
The Average Directional Index (ADX) helps show whether a market is in a trend or not. The ADX line is plotted below the chart with values
ranging from 0 to 100. A reading below 25 is general considered to mean that there is no positive up or down trend in play.
The below chart highlights where a strong trend was in play that was then followed by sideways movement. The fall in the ADX towards
the end of January and subsequent failure to move beyond 40 again signalled the end of the strong bull run for EURUSD. Since then the
Bollinger Bands
market has faded sideways and the ADX has slipped below 25.
Bollinger Bands are particularly useful for range traders. First, the
bands help define overbought and oversold conditions. As prices
EURUSD – decline in ADX off highs signals market moving sideways reach and then move beyond the upper and lower bands the
market is becoming respectively overbought or oversold.

Secondly, by design prices to move between the bands, thereby

helping to define price targets.

Prices have a tendency to swing from one extreme to the other.

If price touches the upper band, a reasonable price target would
constitute the lower band level.

However, it is worth noting that prices are as likely to continue to

move beyond the bands as they are to retrace back between the
sideway trend
two bands. In other words, just because a market is overbought
strong uptrend does not mean it cannot keep rising.

Traders should seek to confirm signals by looking at the price, chart

formations, other indicators, candles patterns and established
areas of support and resistance.
ADX lower highs sign
als
declining force in tr
end sideways trend Finally they can help predict a breakout. When the bands narrow,
a sharp move in prices is expected, although the indicator does
not predict in which direction that may be.

Source: ETX Capital

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CCI
GBPUSD – CCI and price signals
The Commodity Channel Index (CCI) was established to identify
turning points in markets that move in cycles. It is also useful in
helping to identify overbought and oversold conditions. Usually
this oscillates between -100 and +100, although it is unbounded, so
can potentially go a lot higher or lower depending on the strength
1 2 3
of trend. However because this range is fairly common, in practice
many traders only consider overbought and oversold conditions
to be met when the indicator reaches +200/-200. As each market
can vary in terms of its volatility, it is often wise to optimise, for
instance by looking at historic trends to identify when a particular
market moves beyond its usual limits.

Using the CCI alone is clearly not enough – too many false signals
can be given since, as we have previously noted, prices are as likely
to continue rising when technically ‘overbought’ or continue falling false signal
when technically ‘oversold’. 1 2 3

We must consider both the signals suggested by the CCI and the
security’s price in relation to the range. For instance, if the market
reaches an established resistance level and the CCI indicator is well Source: ETX Capital

above 100, and then starts to turn lower below the overbought
line, then it may be a good time to open a short position.

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RSI
The Relative Strength Index (RSI) also produces signals based on GBPUSD – RSI and price signals
overbought and oversold conditions. The RSI is a line oscillates
between 0 and 100.

Markets are said to be overbought if the RSI rises above 70 and

1 2 3
oversold if it falls below 30. This can be modified to 80/20 for a
market that is a strong trend.

A
For the range trader, again we are looking for a market to be
overextended – above 70 or below 30 – and for a turn in the RSI
into the normal parameters, ie between 30 and 70. If this occurs
as the price of the security reaches an established level of support
or resistance it may be a good time to enter the market, with the
expectation that the RSI is signalling a change in direction back 2
1 3
into the middle of the range.

Source: ETX Capital

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