What is 'Range-Bound Trading'

Range-bound trading is a trading strategy that seeks to identify and capitalize on stocks trading in price channels. After finding major support and resistance levels and connecting them with horizontal trend lines, a trader can buy a security at the lower trend line support (bottom of the channel) and sells them the upper trend line resistance (top of the channel).

BREAKING DOWN 'Range-Bound Trading'

Range-bound trading strategies involve connecting reaction highs and lows with horizontal trend lines to identify areas of support and resistance. The strength, or reliability, of the trend line as an area of support or resistance depends on the number of times the price has reacted to it. For example, if the price has moved lower off of the resistance trend line five or four times, it's considered more reliable than if the price only moved off of it two times.

Traders capitalize on range-bound trading by repeatedly buying at the support trend line and selling at the resistance trend line until the security breaks out from a price channel. The idea is that the price is more likely to rebound from these levels than break through them, which puts the risk-to-reward ratio in their favor, although it's important to always watch for a potential breakout or breakdown.

Most traders place stop-loss points just above the upper and lower trend lines to mitigate the risk of heavy losses from a high volume breakout or breakdown. For example, if a security has a lower support trend line at $10.00 and an upper resistance trend line at $15.00, the trader may purchase the stock at $11.00, just after a rebound, with a stop-loss of $9.00. This protects the trader if the stock broke down from the support trend line.

Many traders also use other forms of technical analysis in conjunction with price channels to increase their odds of success. For instance, traders might watch the volume associated with a rebound from a support level to gauge the likelihood of a breakdown or breakout. The relative strength index (RSI) is also a useful indicator of the trend strength at any give point within a price channel.

Range-bound Trading Example

The following chart shows an example of a range-bound trading strategy with arrows in place for potential long and short trades.

Range-Bound Chart Example

In this chart, a trader may have noticed that the stock was starting to form a price channel in late-October and early-November. After the initial peaks were formed, the trader may have started placing long and short trades based on these trend lines, with a total of four short trades and two long trades. The stock's breakout from upper trend line resistance marks an end to the range-bound trading.

Chart courtesy of StockCharts.com.

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