Friday, May 09, 2008

Six Signs of a Range Bound Market

Several traders emailed me yesterday, tripped up by the narrow, range market. After a period of volatility such as we had during the first quarter of 2008, it is understandable that traders expect moves to extend. In a range market, however, reversals of market moves are the order of the day. If traders don't recognize the character of the day early, it's easy to get chopped up in those reversals.

Here are several cues I rely upon in gauging a possible range day. Not all of these are present on all of the days, and not all of these pertain to yesterday. As a whole, however, I've found these to be relatively accurate guides that help me pull back my trading, enter trades only near range extremes, and take profits more quickly than I would in a trending market.

1) Other, related markets are range bound - If the interest rate markets are in a narrow range, there may be little reason for investors to reprice equities;

2) Little news - Either there is no news and no economic reports, or the news and reports that come out fail to move interest rates, currencies, etc. Per number one above, that means that the news has not significantly impacted investor expectations, and there's little reason to move value;

3) Decreased volume - Often this is a first signal: Volume either starts the day well below recent norms, or quickly tails off to below average as the day goes on. This means that the large institutional participants that move markets (and ultimately set value) are not active and trade will be dominated, in relative terms, by market makers;

4) Narrow breadth - When we get an initial market move for the morning, it occurs on narrow breadth, with advancing and declining issues relatively balanced. That tells us that the move is not a broad trend;

5) Sector rotation - When we get that initial market move in the morning, some sectors may be up quite a bit (energy, for instance) and some might be down quite a bit (financials). When sectors are taking their separate paths, there is no general trend to the market;

6) Initial trades don't work - A scratched trade often provides market information. If you catch an early market move and then it reverses on you before it hits an expectable price target, you have an early indication of the character of the day. It's worth paying attention to good trade ideas that don't pay you out.

The main thing is to not overtrade these narrow days. If a market is trading in a range, the best trades are to fade moves around the range extremes. Since moves tend not to extend, it's necessary to take profits more aggressively than you ordinarily would.

As the VIX grinds to new lows and we get closer to possible summer doldrums, we may see an increasing number of these narrow days. If you can recognize them early, you can preserve your capital and maybe even make a little money.

RELATED POST:

Volume and Opportunity in the Market
.

3 comments:

Globetrader said...

Brett,

I found a different approach to the problem of small range days. I try to go to the market, where my system works best.

By following multiple markets usually you will find one suited to your trading style. It's difficult to learn the patterns of not only one but multiple markets, but it pays of on days like yesterday.
As a US trader you might first take a look at the European indexes and how they moved while you were sleeping. What moves do you see in the EuroStoxx50, in the DAX and in the FTSE futures. If you notice small ranges in these markets and there is nothing important on the newsfront, then expect further consolidation at least until lunchtime. If Europe was volatile, then you can expect that volatility to continue. It's just a rule of thumb, but you need something to start the day with. (I do the same in the morning by looking at the SPI, the NIKKEI and the HSI)

Now if you are a trend trader and you can expect a small range day looking at the way Europe traded so far, then you might switch to currencies (Euro/USD), to Gold or to Oil trading. These markets move only losely correlated to one another, so one of these might show the volatility and range you need for your system to work.

But even if you limit yourself to equity indexes, it pays off to follow different markets. Index is not index and even if you can expect all equity index markets to be highly correlated, there are differences and on small range days you can exploit these without increasing your risk profile.

The German DAX usually moves 5 to 10 points when the ES moves 2 to 3. The british FTSE moves even more and has the advantage of a smaller tickvalue (DAX minimumtick is 0.5 with a value of 12.5 Euro or 19.25$. The FTSE also has a minimumtick of 0.5, but the tickvalue is 5 british Pound or 9.75$ and the margin necessary is considerably lower).

Chris

Michael said...

#4 was a big clue to me yesterday. I think I watched the A/D line flip from positive to negative and back to positive all within the first hour. Then I IM'ed a friend of mine that it was looking like we were in for a chopfest.

AVP said...

I think range bound markets are the most difficult to day trade.

There are a lot of chances to get whipsawed often if stops are misjudged,however one good thing about the ranges can be the way stops can be put with some degree of certainty (some points below support for longs and some points above resistance for shorts).

Profits do reduce due to low volume,prices move very very slowly,profits need to be taken at first sign of a favourable trade.

Just my 2 cents.

Cheers,
AVP
http://avp-blogs.blogspot.com