What Is a Sideways Market?
A sideways market, or sideways drift, occurs where the price of a security trades within a fairly stable range without forming any distinct trends over some period of time. Price action instead oscillates in a horizontal range or channel, with neither the bulls nor bears taking control of prices.
The opposite of a sideways market is a trending market.
- A sideways market, sometimes called sideways drift, refers to when asset prices fluctuate within a tight range for an extended period of time without trending one way or the other.
- Sideways markets are typically described by regions of price support and resistance within which the price oscillates.
- Trading a sideways market can be tricky, but certain options strategy maximize their payoff in such situations.
The Basics of a Sideways Market
A sideways market consists of relatively horizontal price movements that occur when the forces of supply and demand are nearly equal for some period of time. This typically occurs during a period of consolidation before the price continues a prior trend or reverses into a new trend. Sideways markets are generally the result of a price traveling between strong levels of support and resistance. It is not uncommon to see a horizontal trend dominate the price action of a specific asset for a prolonged period before starting a new trend higher or lower. These periods of consolidation are often needed during prolonged trends, as it is nearly impossible for such large price moves to sustain themselves over the longer term.
Volume, which is an important trading indicator, mostly remains flat during a sideways market because it is equally balanced between bulls and bears. It shoots up (or down) sharply in one direction, when a breakout (or breakdown) is expected to occur.
When analyzing sideways markets, traders should look at other technical indicators and chart patterns to provide an indicator of where the price may be headed and when a breakout or breakdown may be likely to occur.
Sideways markets may be referred to as choppy or non-trending markets if there are a series of swings up and down, but which keep reverting back to some average level. If the sideways drift is expected to remain for an extended period, investors can profit by selling call and put options with approaching expiration dates.
Profiting from Sideways Markets
There are many different ways to profit from sideways trends depending on their characteristics. Typically, traders will look for confirmations of a breakout or breakdown in the form of either technical indicators or chart patterns, or seek to capitalize on the sideways price movement itself using a variety of different strategies. Market participants can exploit a sideways market by anticipating breakouts, either above or below the trading range, or by attempting to profit as price moves between support and resistance within the sideways drift. Traders who use a range-bound strategy should make sure the sideways market is wide enough to set a risk-reward ratio of at least 2:1—this means that for every dollar risked, investors make two dollars of profit.
Many traders focus on identifying horizontal price channels that contain a sideways trend. If the price has regularly rebounded from support and resistance levels, traders may try to buy the security when the price is nearing support levels and sell when the price is nearing resistance levels. Stop-loss levels may be put into place just above or below these levels in case a breakout occurs.
Qualified traders may also use options strategies to profit from sideways price movements. For example, straddles and strangles can be used by options traders that predict that the price will remain within a certain range. For instance, you could sell a straddle -- both an at-the-money call and a put option for the same underlying asset in the same strike and same expiration month. As the options' expiration date approaches, the option premiums are eroded by time decay—and ultimately if the market remains sideways will decay to zero. However, it's important to note that these options may lose all of their value if the stock moves beyond these bounds, making the strategies riskier than buying and selling stock.
Benefits of Trading a Sideways Market
Clear Entries and Exits: A sideways market usually has clearly defined support and resistance levels, which removes ambiguity about where to place entries and exits. For example, a trader can buy a security when its price tests support and set a profit target at resistance. A stop-loss order placed slightly below the sideways market’s support level minimizes the trade's downside.
Risk and Control: Traders chase smaller profits when trading a sideways market; therefore, each trade is typically not open for more than a few days or weeks. This reduces the chance of a position being adversely affected by a bear market or unexpected news event, such as a terror incident. Trading in a sideways market allows traders to close any open positions before company announcements, such as earnings reports, and re-enter when the security’s price returns to support.
Limitations of Trading a Sideways Market
Higher Transaction Costs: Trading a sideways market typically presents more trading opportunities than trading a trend. As a security's price moves within a range, traders can continually buy at support and sell at resistance. Frequent trading generates commissions that eat into a trader’s profits. Traders who employ range-bound strategies do not have the advantage of letting their profits run to offset commission charges.
Time Consuming: Frequently buying and selling a security to seek out a profit in a sideways market is time-consuming. Traders need to determine their entry and exit as well as place a stop-loss order. After entering a trade, it has to be carefully monitored to ensure correct execution. Many traders have automated their trading strategies to avoid having to sit in front of their monitors all day.