Pros and Cons of Range Trading

I expect you’ve seen the ads … “become a millionaire by making just 10 pips a day” … I mean, how hard can it be to earn 10 pips a day? That’s next to nothing?

And, if you look at the maths, making just 10 pips each day, even starting small, you’ll soon be trading with huge stakes and pulling in hundreds of pounds each time you enter the market.

Sounds like easy money?

Right?

Well …

I know I talk a lot about the beauty of riding long-term trends … about using trailing stops to let our profits run and run …

But I realise that that kind of trading isn’t for everyone, and it isn’t for all markets. So today I’m going to dig a bit deeper into how we can pick up small moves from trading markets that are stuck in a range. And we’ll see whether it really is possible to ‘get rich’ from gathering these ‘quick and easy’ profits.

Con #1: The cost

Trading small ranges for a few pips profit is generally known as scalping. And scalping strategies are extremely popular, especially with newcomers to trading, who are attracted by the fact that you can get ‘in on the action’ with a relatively small fund.

But the idea that scalping is a cheap way to trade is completely wrong. It involves paying out a huge share of your winnings to your broker.

Let’s say that you’re looking to make 5 pips profit on a trade … but your broker is charging you 1 point spread. That’s 20% of your profits already eaten up before you’ve got off the starting block (and that’s assuming you win every trade!)

This makes it a very tough way to make money.

Con #2: Rapid decision-making

The tighter the range you’re trading, the more important it is to be ready to act at the exact moment the market has swung, so you can maximize your profits. This requires confident, fast decision making … which can be very tough when your money is on the line.

Con #3: Pin-point entries & exits

This is linked to the last point, about needing rapid, confident entries and exits. But it’s important to note with trading tight ranges that getting your entry or exit just a point or two out, will make a huge percentage difference to your profitability (often tipping you into the red).

Con #4: The Limitations

One of the joys of trend trading is when the market has made its move … you’re well into profit, and your trailing stop is already locking those profits in. It’s a nice place to be, where you’re making risk-free money!

Of course, it doesn’t happen all the time, but if you’re trading a range, you’ll never get that relaxed feeling. Every point counts, and you have to be vigilant in fighting for every point you can.

Pro #1: Small starting fund

Probably the biggest attraction to this type of trading comes from the size of the starting fund.

If you want to start trading a long-term trend-following method, you’re likely to have a stop distance of 100 pips or more. If the minimum stake for that market is £1, then that’s a £100 minimum risk per trade. And if you’re risking 2% per trade, that means you’ll need a trading fund of £5,000.

Many traders (especially those just starting out) don’t want to pile that kind of money into a new trading method.

Therefore, when we see a trading method with a 10-point stop distance, where we only need to risk £10 a time … it’s got instant appeal. We can start small, and build our trading fund from there.

While there’s good logic to this, and to keeping risk manageable, it’s important to remember that this kind of trading is expensive in terms of costs to your broker – and those of us with modest funds, shouldn’t be paying out more than we can afford to our brokers!

NOTE: As of this summer, new ESMA rules on margin requirements mean that more of us will be feeling the pinch, and looking for ways to trade with smaller funds – these tighter ranges could be just the thing, so now’s a great time to hone our skills in this type of trading.

Pro #2: Familiar territory

There are few things traders like more than bringing some order to the uncertainty of financial markets. And one of the simplest ways we do this is by drawing a line on our charts, and telling ourselves that ‘something will happen here’. We can’t be sure if the price will bounce or it’ll breakout, but we know this is a key point.

And trading ranges gives us clear levels to work between. While trading trends can lead us into unfamiliar territory, where markets keep going higher, while doomsayers tell us that ‘it’s a bubble’ … ‘it’s about to crash’ …

The range trader has seen price action at these levels before, and has a clear picture of how they expect prices to behave again.

Pro #3: clear stops and targets

Because range trading is based around price behaviour at these levels in the recent past … we’re able to draw these clear lines on our charts, where we want to take profits, or cut our losses.

The trend trader never knows how far the market will run … or whether they are looking at a minor correction or a full-blown reversal. But the range trader can quickly spot when the price has moved out of their range, and quickly knows when to cut losses.

Pro #4: No waiting around

The more time our money sits in an open trade, the greater the risk it’s at. So, if we can hit our profit target quickly, and get that cash back into the safety of our account, that’s always a good thing.

Building a case

So, having weighed up the pros and the cons … can we make range trading work?

To be successful at this type of trading, it’s all about finding a balance, so that the benefits won’t get overwhelmed by the downside. It’s about keeping costs down so they aren’t eating all our profits … ensuring that our win rate is sufficiently high to cope with a risk/reward profile that could be pretty tight … and having very clear rules, so we don’t have to dither when it comes to pulling the trigger.

Here are a few tips …

• Choose your instrument carefully. Look at the spread cost for trading each market you’re considering, and weigh this up against the average daily range of that instrument and the average profit distance for your trades.

For example, if you’re looking at USDJPY, it may have an average daily range of 70 pips, and a spread cost of 0.7. If you’re looking to make 10 pips profit on a trade, remember that 7% of that will be eaten up by trade costs.

Compare that to trading Silver, with an average range of just 25 points, and a spread of 3 points. With such a tight range, you’d struggle to catch short-term swings of 10 points – plus, you’d be giving back 30% on all trades.

Look carefully at your instrument for the kind of move sizes you can catch, and weigh this up against costs (remembering that you pay costs on the trades you lose, as well as on your winnings.)

• Ruthlessly reject weak trades. If you’re trading a tight range, it’s vital to get a good entry, where there’s sufficient distance for the price to run. If the market has already moved through 7 pips of a 15-pip range, then you’ve probably missed that opportunity, so should sit out. Set yourself a minimum distance you’ll accept, and be strict about not taking trades where the profit opportunities just aren’t good enough.

• Monitor your results very carefully. Trading in these tight parameters is a balancing act, so it’s crucial to track how your win rate is performing, along with your average win size vs your average loss size. If you’re unsure about this, the Trader’s Bulletin spreadsheet can do the work for you. It’s downloadable from HERE.

Ironically, with the new rules being brought in to ‘protect’ traders, it’s this kind of trading that we’ll be drawn into – the kind of trading where we have to work a bit harder, and we’re more likely to make our brokers rich!

But we shouldn’t be cowed by it – the opportunities are there, and over the coming months we’ll be looking at lot closer at finding powerful ways to access these profits.

To enjoy more content and get it faster Follow @TradersBulletin