Avoiding trading in ranging markets
The beginner strategy is a trend following trading strategy, i.e. it works better when the market is trending.
This is because if the market is trending, then your profit targets are more likely to get hit, so long as you trade in that direction.
There is therefore an advantage to being able to identify when the market is trending and when it is ranging, because you can avoid ranging market conditions and reduce the likelihood of unprofitable trades by waiting for a price breakout.
This is called filtering, a way of avoiding certain market conditions to avoid unprofitable trades – in this case, avoiding ranging markets. Once you have identified a ranging market, then you can wait until the price breaks out of that range before you start to look for trades.
The chart below shows an example of the price breaking out of a range:
- The price is ranging
- Upper boundary of the range
- Price breaks through this range to the upside
- Price is in a trend
A price range has an upper and lower boundary
An effective method of determining a price range is to identify the upper and lower boundary and place support and resistance levels at them. Then when the price breaks out of the range you can begin to look for trading opportunities.
You can see in the chart below that the shaded area, shown at 1, is in a clear range between the resistance level, shown at 2, and the support level shown at 3. The price then breaks out of this range and enters into a trend, shown as 4.
- Ranging market
- Resistance level
- Support level
- Trending market
A hint to see if the market is ranging, is to look at the candlestick formations. If the candlesticks are unusually short and have long wicks, then this is further indication that neither the buyers nor the sellers are managing to gain momentum.
You can see in the chart above that the candles within the range highlighted in the shaded area 1, are distinctly smaller than those outside the range.
Applying range break out to the beginner strategy
To include this filter into the beginner strategy, you start by determining the direction on the 30 minute chart as per usual. Once you switch to the five minute chart, you refrain from looking for any new opportunities until the price breaks out of that range.
You should note that after the price has broken out of the range, you go through the whole process of looking for a setup. So, if the market direction is down, then after the price has broken out of the range, you must first look for a broken up fractal and then look for a broken down fractal to enter – and vice versa if the market direction is up.
To illustrate this, take a look at the chart below where we show the same example as above, but applied to the beginner strategy – in this situation, the market direction is down:
After the price has broken out of the range, you then look for the up fractal to be broken, shown as 1. Then you enter when the down fractal is broken, shown as orange 1.
You can filter trades using support and resistance
Sometimes the market will be ranging, but the range will not be the tight range that has been shown above. Sometimes there can be a reasonable enough distance between the upper and lower boundaries to enter trades in between.
If you identify an upper and lower boundary of a range, this means you can avoid trades if the entry is too close to the upper boundary for a long trade and too close to the lower boundary for a short trade.
To do this, you can look for the most recent support and resistance levels on the 5 minute chart. Take a look at the chart below:
- Resistance zone
- Support zone
You can see that there is a clear zone of support and resistance that you can use to filter your trades. You do not have to search for support and resistance levels on higher times frames, just the most recent support and resistance levels on the 5 minute time frame where you are looking to enter into a trade.
In the following example, we demonstrate how you can apply this to the beginner strategy – in this example the market direction is up.
The down fractal has been broken at 1 and using the traditional rules of the beginner strategy, the entry would have been at 2. However, it is very close to the resistance zone. Waiting for the price to break out of the range to the upside and then take an entry, shown as 3 gives you a better chance of a profitable trade.
So far you have learned that:
- the beginner strategy is a trend following trading strategy and so there is a distinct advantage to be able to recognise when the market is not trending.
- you can apply filters, ways to avoiding certain market conditions, such as ranging markets, to decrease the amount of unprofitable trades.
- you can apply support and resistance levels to highlight a range, and then look for trading opportunities when the price has broken out of that range.
- significantly smaller candles are also an indication that there is no momentum in either direction.
- you can also filter trades by avoiding entries that are too close to a resistance level in a buying opportunity or too close to a support level in a selling opportunity.
- instead you can wait until the price breaks out of the range before entering into the trade.