Choppy Range-Bound Markets: The Five Most Useful Technical Indicators to Identify Them
When the values of assets do not move significantly from one end of a tight range to the other for an extended period of time, this type of market is known as a range-bound or sideways market.
They do not create new highs and they are unable to break out above the previous high. If they did, it would be an indication that a bull market was about to begin.
They don’t fall below the previous level of support, and they don’t generate new lows that are lower than the previous ones. If they did, it indicates that they committed an error of judgement. If the market were to decline by at least 20 percent, we would call it a bear market.
But how can we recognise such range-bound markets and engage in trade in them? Therefore, in today’s column, we will talk about six technical indicators that may be used in markets that are choppy and range-bound.
What exactly is meant by trading within a range?
A trading approach known as range-bound trading seeks to identify securities trading in price channels, such as stocks, in order to capitalise on price fluctuations and turn a profit.
After locating significant support and resistance levels and linking them with horizontal trendlines, a trader has the opportunity to purchase a security at the lower trendline support (the bottom of the channel), and then sell it at the higher trendline resistance (the top of the channel) (top of the channel).
The term “trading range” refers to the period of time during which the price of a security trades between a consistent high and a constant low. Price support and price resistance are often located at the top and bottom of a security’s trading range, respectively. Price resistance is typically found at the top of a security’s trading range.
Traders can make a profit from trading inside a narrow range by buying and selling at the trendlines that indicate support and resistance until the security breaks out of the price channel.
Despite the fact that a possible breakout or breakdown should always be kept in mind, the theory goes that the price is more likely to rebound from these levels than to break through them. This puts the risk-to-reward ratio in their favour and puts the odds in their favour.
Now that we have that out of the way, let’s talk about the technical indicators that assist us identify range-bound markets:
5 Technical Indicators That Can Help You Navigate Choppy and Range-Bound Markets
You may determine whether a market is range-bound by using any one of the following five technical indicators:
Average True Range
The Average True Range, often known as ATR, is a measure of volatility that looks at the price activity of a security over a predetermined time period.
After subtracting the high from the low of a single price bar, the next step is to compare the resulting value to the price ranges shown in earlier price bars. The final estimate is based on a smoothed moving average of these values (actual ranges) across N periods, where N is the technician’s desired time setting. This average was calculated using a moving smoothing method. 14 days is the ATR setting that is used most frequently (or cycles).
The formula does not suggest the direction in which prices will move; rather, shares whose ATR values are high are more volatile than equities whose ATR readings are low.
Instead, it is a supplementary technical tool that complements trend-following and momentum indicators in order to achieve the best possible results. A number of traders construct their exit strategies by using ATR multiples.
When the ADX is lower than 25, a market is said to be range-bound. On the other hand, an indication that the market is about to enter the trending phase is given if the value of ADX rises over 25 from below.
The Bollinger Band is a robust indicator that gives traders a variety of trading indications to use in their analysis. The vast majority of traders make use of it as a momentum indicator as well as a volatility channel. Traders also utilise the upper and lower bands as a volatility channel in order to search for market volatility cues.
Traders pay close attention to the Bollinger Bands squeeze, which takes place when the upper and lower bands of the Bollinger Bands converge or come together, typically after a period of trending.
A squeeze or contraction of the Bollinger Bands suggests that there is little volatility in the market being measured. In the financial market, periods of low volatility are typically followed by times of high volatility. This pattern provides market participants with a profitable chance to profit from the subsequent or expected shift in the market.
When used to range-bound markets, Bollinger Bands perform their best. When the bands are narrow and contradictory, price volatility is minimal, and the price moves in just one direction, which is indicative of a market that is range-bound.
When the bands begin to widen, there is a subsequent rise in volatility, which in turn causes prices to begin trending.
In range-bound markets, such as those represented by Bollinger bands, Donchian channels also function quite effectively.
Calculations based on moving averages are used to build Donchian Channels, which consist of three lines that are made by upper and lower bands surrounding a central or median band.
The top band indicates the highest price that a security has reached over the previous N periods, while the lower band indicates the lowest price that a security has reached during the previous N times. The region that lies between the top and lower bands is known as the Donchian Channel.
When the bands are narrow and contradictory, price volatility is minimal, and the price moves in just one direction, which is indicative of a market that is range-bound.
The volatility skew is a concept in options trading that postulates that option contracts for the same underlying asset but with different strike prices and the same expiry date will have varied implied volatilities (IV).
Skew analyses the difference in intrinsic value (IV) between at-the-money, in-the-money, and out-of-the-money options.
When the ratio of this indicator is between 1.3 and 0.80, it suggests that market players are uncertain and waiting for confirmation on either side. When the ratio is outside of this range, it shows that the market participants are confident.
Index of the PCR OI
The Put/Call Ratio (PCR) is a well-known derivative indicator that is utilised by traders to assist them in determining the general attitude of the market (mood). The ratio is computed by applying the volume of option trading or the open interest for a specific time period.
If the ratio is larger than one, this implies that more put options were traded throughout the day. On the other hand, if the ratio is less than one, this suggests that more call options were exchanged.
It is possible to make an estimate of the PCR for the whole options market, which includes both individual stocks and indexes.
Range-bound market conditions are indicated whenever the PCR OI is in the range of 0.95 to 1.05 in either direction.
The signs that are shown above will assist you in recognising a market that is range-bound or moving sideways. It is important to keep in mind that regardless of whether you are trading in a trending or range environment, you should take solace in the fact that it is possible to make a profit in either scenario.
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