Some people will only trade trends … some people hate trend following …
I’m afraid, in the big trend vs range debate, I don’t come down on one side of the other … I do both.
I firmly believe that both can be powerful in the right circumstances.
But it’s vital to know WHEN to apply each, because they are fundamentally different in the way we manage our entries, our exits and risk.
A trend is normally defined as a series of higher lows (in the case of an uptrend) or lower highs (in the case of a downtrend).
It’s easy to see what’s attractive about trend trading. We can catch huge market moves, making a large number of points in just one trade.
What’s not to love?
The range trader is the introvert of the markets, looking for more modest moves.
A range trader is looking for prices moving between areas of support and resistance.
As you can see from the chart above, the range trader needs a wide enough stop level to cope with false breakouts, and his profit target needs to take into account that the price may only move two-thirds of the way to the retracement level.
Of course, ranges don’t have to be horizontal lines – the range trader can follow the up and down swings in a trend …
Ranges can also be technical – based on Bollinger bands, pivot points or Fibonacci levels.
In general, we’ll expect a trend-trading strategy to have stop distances that are relatively tight, and profit targets that are ambitious, giving a nice generous risk-reward ratio.
By contrast, a range-bound strategy might be trading a narrow range, perhaps only going for 1:1 RRR.
Because range trading is based around price behaviour at 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.
Markets spend very little of their time moving in nice straight lines from A to B. And they spend a lot of their time bouncing around in untidy retracements.
As a result, those substantial trend moves don’t come along very often, so the trend trader may have to be patient in waiting for the big payoff. Trend-following systems will often have a very low success rate, relying on big-money trades to make up for lots of false signals along the way.
Those big winners are a definite feel-good factor for the trend trader, but they come at a price.
A trend trader will tend to have lots of small losses, and a few big winners.
It can be tough trading this way, waiting for those winners to come along.
On the flip side, the range trader tends to be under more pressure on his or her entries – just a few points wasted in dithering over a trade can wipe out profits entirely.
The obvious answer is that a trend-following method will work in a trending market, and a range-trading method will work in a range-bound market.
And it’s wonderfully easy to spot when these periods are in retrospect …
There are indicators we can use to judge the strength of a trend, and the momentum behind it, but I want to look here at what techniques have the most success … and when.
The stats show that more likely to make money day trading if you’re trading quiet times, with lower volume and tighter ranges – this is prime range-trading territory.
The charts below show the percentage of traders winning according to the time of day they are opening the trade, and the average pip move on the instrument at that time …
What’s clear is that people are more successful trading the quiet down-times when ranges are tighter.
It goes against what a lot of traders believe – i.e. that we should be grabbing the peak volatility of the day.
With that in mind, if we’re day trading – range-bound opportunities look like the best options.
But, hands down, the most profitable traders of all are those who take long-term positions, and these will tend to be trend-following.
As I said at the beginning of this post – I don’t see any reason to choose between range or trend. We can benefit from both. It’s just about matching your strategy to the market.
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