Identifying Trend and Range
The ability to identifying Ranges and Trends is crucial for your trading success. In this article we will describe the difference between the two, introduce a simple tool to differentiate and the trading attitudes one must implement in each phase to maximize its profits.
Background
We will start by several declarations:
Trend - Directional movement of price.
Range - Random movement of price, usually from levels of Support and Resistance and without any order or direction.
Some statistics - in about 85% of the time price is ranging and trends are only present in 15% of the time. That means that in 85% of the time, price moves from a support level to a resistance one, and vice versa. This makes plenty of room for chartists to take advantage of the bounces from psychological levels and chart patterns - and create profits.
Why Does It Matter
Trends are highly different from Ranging periods, especially in the trades you will take. By learning the best trades in each phase you will become a better trader and could function in all market environments.
In periods of Trend, we will take only trades in the general direction of the market. This can be done by waiting for retracement to a Fibonacci level or a Moving Average. Trying to predict reversal of trends when the trend is strong is highly unstable way of trading and can result in big losses. This is a period where the general direction is known, and we will look for precise points to join the main trend.
Fig. 1: Long trade is issued after price retraced to a Moving Average
Fig. 2: Short trade is issued after price retraced to a Moving Average. Note that Moving Average should be sloped
However, in ranging periods the trading rules change. Price ranges from Support and Resistance and therefore we can take reversal signals with much higher probability of success. We can take long trades on Support and short trades on Resistance with higher performance, because there is no strong trend to block our signals. Chart Patterns are also enforced in ranging periods - and pullbacks & breakouts tend to give better signals in ranging periods.
Fig. 2: In Ranging phases, Chart Patterns start to appear
Most people does not differentiate between these two phases of the market - and therefore decrease their trading performance and prevent themselves from learning and improving. We advise you to design trading rules for trend phase as for range phase, so you will be able to create profits under any market environment and will not depend on a single market phase. We will now describe a simple yet highly effective way of identifying ranges and trends.
Bollinger Bands
The Bollinger Bands are an extremely efficient tool for identifying periods of trends and ranges. This is done via the Middle Band - the 20-period Simple Moving Average. This method is also described in the article 'Trading With Bollinger Bands'.
The Middle Band's slope defines the phase of the market. If the Middle Band is flat and horizontal, we are in ranging period and trend is very weak. As the Middle Band slope becomes steeper - trend is stronger.
Fig. 3: Moving Average slope defines Trend or Range
In Conclusion
The Bollinger Bands can give an accurate perspective on the market phase and help you decide whether it is a ranging phase or trend. Using this information the trader could change his attitude to fit in the markets behavior:
Chart Patterns and Support and Resistance levels will be traded in Ranging periods,
and retracements and Moving Average crosses will be traded in Trending periods.
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