What is Range Trading?

Investors and traders employ numerous strategies based on their risk appetite, reward expectations, objectives and outlook. Range trading is one such strategy that is employed by experienced traders. Let’s discuss the concept of range trading, related strategies, the risk involved and limitations.

What is Range Trading?

It is a short-term strategy that involves actively buying and selling securities within a specified price range. For example, the current market price of HDFC Bank is Rs. 1400 and is expected to increase to Rs. 1450 over the next few weeks. In this case, the range for trading is between Rs. 1400 and Rs. 1450. Ideally, you must aim to purchase the stock at Rs. 1400 and sell if it rises to Rs. 1450. The process is repeated till the stock is perceived to trade outside the range. Range trading is a versatile concept and may be applied to most investments including stocks, bonds, mutual funds, ETFs, etc.

The crux of range trading is market timings which refer to the time frame for which an investment or security is expected to trade between two prices. Market timings must be precise since a position can result in losses if the stock price does not move in the anticipated direction over the time horizon of the investment.

Besides Market timing, volume is significant to range trading. Analyzing volume trends helps to validate whether the timing is right to use a range trading strategy by predicting patterns. Technical analysts believe that volume precedes price movement. To confirm a trend, the volume must increase in the direction of the trend.

Price volatility poses considerable risk to range trading. The risk involved may be gauged by the trading range of a security. To mitigate the risk, range trading must be applied to securities with lesser price fluctuations. Alternatively, stable sectors such as healthcare, FMCG, telecom tend to be less volatile. Cyclical sectors such as metals, technologies, commodities are comparatively subject to price fluctuations. High-beta securities also have wider ranges as compared to low-beta securities.

Thus, it is worthwhile for an investor to undertake thorough research and an in-depth price movement analysis before entering into range trading.

Strategies of Range Trading

As discussed above, range trading involves identifying substantial price levels. Thus some of the strategies used in range trading include support and resistance and moving averages. Support refers to a price level where the demand is too high to prevent the price of the security from falling further. The reason being as the price moves closer to support, the demand for the security increases whereas the supply reduces. The number of buyers increases although the sellers become less willing to less. Conversely, resistance is a price level where the supply is strong enough to prevent the price from rising more. At the resistance level, sellers become more inclined to sell as opposed to buyers who are less willing to buy. To maximize profits from range trading, traders must buy at support and sell at resistance.

Another strategy commonly applied for range trading is moving averages. Before executing a trade, market trend within an aligned time frame is to be evaluated. In this context, market trend refers to whether the security is trading within a range. If there is no trend then range trading is fit for execution. However, if the price of the security appears to be moving in a particular trend, then the concept of range trading is negated.

Example of Range Trading

A trader must actively track the price movements of the security or sector to identify the scope of range trading. Suppose the price movement for Reliance Industries Limited is as below:

The trader identifies that the shares of Reliance Industries have been oscillating in the range of Rs. 1800 and Rs. 1950 for a fortnight. Additionally, there is no increasing or decreasing trend in price movement. Lastly, the trader expects the price movement to continue within the range for the next 30 days and concludes that range trading can be applied. The floor price is Rs. 1800 and the ceiling price is Rs. 1950.

Thus, on 17th November the market price is close to the floor price and the trader purchases 100 shares. On 25th November, the market price reaches Rs. 1940 and the trader liquidates his holding. Again on 1st December, the share price is Rs. 1850 and the trader repurchases the shares. On 15th December, the share price is Rs. 1870. The trader will still liquidate his holding since the time frame for range trading is 30 days.

In conclusion, while range trading is an effective strategy, it entails market timing which is difficult to estimate. Placing a stop-limit order to sell at price below the purchase price may be considered to control the loss which may arise from the trade.