A range-bound or sideways market appears when the prices of investments stay in a narrow range for an extended time.
They don’t make new highs or break out above the prior high. If they did, it would signal the start of a bull market.
They don’t dip below the prior level of support or create lower lows. If they did, it means they made a mistake. A bear market would be defined as a drop of 20% or more.
But how do we identify and trade in such range-bound markets? So, in this blog, we will decipher 6 Technical Indicators to use in Choppy Range-Bound Markets.
What do you mean by range-bound trading?
Table of Contents
Range-bound trading is a technique that focuses on detecting and profiting from securities trading in price channels, such as stocks.
For instance, a trader can purchase any security at the low trendline support. Further, he can sell it at the upper trendline resistance after determinating necessary support and resistance levels and connecting them with horizontal trendlines.
When any securities trades between constant high and low prices for a while, this is called a trading range. Price resistance is usually found at the top of a security’s trading range, while price support is usually at the bottom.
Traders profit from range-bound trading by buying and selling at the support and resistance trendlines until the security breaks out of the price channel.
Clearly, the thing is that the price is likely to rebound from these levels than break through them, putting the risk-to-reward ratio in their favor, though a potential breakout or breakdown should always be kept in mind.
Now let us discuss the technical indicators that help us identify range-bound markets.
5 Technical Indicators for identifying choppy range-bound markets
Average True Range
The Average True Range (ATR) is an identifying measure of volatility that looks at a security’s price activity over a set period.
The first step is to subtract the high from the low of a single price bar and compare the result to previous price ranges. The final calculation is based on a smoothed moving average of these values (actual ranges) across N periods, with ‘N’ being the technician’s preferred time setting. The most frequent ATR setting is 14 days.
However, the formula does not determine the price direction, but shares with high ATR values are highly volatile than securities with low ATR readings.
Instead, it is a complimentary technical tool that works best with trend-following and momentum indicators. In addition, many traders utilize ATR multiples to develop exit strategies.
Bollinger Bands
The next indicator is known as Bollinger Bands. It is a powerful indicator that provides traders with many trading signals.
Many traders utilize it as a volatility channel and a momentum tool. Furthermore, traders utilize the above and low bands as a volatility channel to look for market volatility cues.
Traders pay great attention to the Bollinger Bands squeeze, which occurs when both the upper and lower bands converge or come together, often after a trending period.
A Bollinger Bands squeeze or contraction indicates little volatility in the underlying market.
Donchian channels
Donchian channels work very well in range-bound markets like Bollinger Band.
Donchian Channels are three lines developed by upper and lower bands near a middle or median band and created using fluctuating average calculations.
The upper band shows a security’s most excellent price over N periods, while the lower band portrays a security’s lowest price over multiple times. The Donchian Channel is the space between the upper and lower bands.
IV Skew
This options trading concept asserts that option contracts for the same underlying asset with different strike prices but the same expiration will have varying implied volatility (IV).
Skew compares the IVs for in-the-money, out-of-the-money, and at-the-money options. When the ratio of this indicator is between 1.3 t0 and 0.80, it shows that the market participants are either confused or waiting for confirmation on either side.
Index PCR OI
The Put/Call Ratio (PCR) is a prominent derivative indicator helping traders determine the market’s overall sentiment. The ratio is derived using option trading volumes or open interest for a certain period.
If the ratio is higher than one, more puts were traded during the entire day, whereas less than one indicates that more calls were traded.
The Put/Call Ratio (PCR) can be estimated for the whole options segment, including individual stocks and indices.
Key features
- Range-bound trading is a technique that focuses on detecting and profiting from securities trading in price channels, such as stocks.
- The Average True Range (ATR) is an identifying measure of volatility that looks at a security’s price activity over a set period.
- Bollinger Band is a powerful indicator that provides traders with many trading signals.
- This options trading concept asserts that option contracts for the same underlying asset with different strike prices but the same expiration will have varying implied volatility (IV).
