The value of a currency pair doesn't trend in one direction; there is no uptrend or downtrend. Rather, the currency pair has specific fluctuations over a week or day that are fairly predictable. Simply put, the currency pair's value zigzags between a high and low.
Range trading is a Forex strategy that takes advantage of these regular fluctuations. For example, a range trader first determines a range, and then might buy into a currency pair at the low end of the range and sell when the currency pair reaches the high end of the range. A reverse trader can also short the range, buying in at the high value and selling at the low value.
To begin, a range trade must first analyse the currency pair. The majority of currency pairs have somewhat predictable swings throughout specific periods of time - it may be over a 4-hour window, 24 hours, or a week. Your technical analysis will give you a better idea of the average time between a high and low. Plus, to determine the range, you must find the currency's signal and resistance prices.
The signal is the current floor for the currency pair, while the resistance is the current ceiling. So for example, if you were examining a GBP/USD pair that fluctuated between 1.5000 and 1.4950; 1.5000 would be the resistance price and 1.4950 would be the signal price. And there would be a 50-pip range for this pair.
Setting Up a Range Trading Strategy
Once the range has been determined - in our example the range is 1.5000 to 1.4950 - you can think about entering and/or exiting trades for the specific currency. With this strategy, the trader would set an entry order for the signal price of 1.4950, and the trader would make a trade at the low end of the range.
Secondly, the trader would set a sell order for the top end of the range, the resistance price of 1.5000. Plus, there's also the possibility of short selling the range, by entering at the high point and selling at the low point.
Using trading software, these orders can be automated based on specific rules. Of course, the currency pair will likely trend out of this range, either above or below. Because of this, it's beneficial for traders to use stop orders above and below the sell or buy order points.
What Are the Benefits of Trend Trading?
One of the biggest advantages of range trading is making profits in a sideways-moving market. Often, day traders prefer to trade trends, as there is greater profit potential with larger movements in one direction.
Yet, although the profit potential in range trading might not be as significant, it does allow traders to profit when currencies aren't trending in one direction, which is happens quite frequently in the Foreign Exchange markets. The general assumption is that 80% of the time the markets trade within a range, rather than trending in one direction.
Another advantage is the simplicity. Once a range has been determined, the trader can set specific entry and exit points. The process is fairly straightforward. Additionally, compared to trend trading, the risk/reward parameters of range trading are much more defined.