While trading in any security market, we often come across a diverse set of prices, some very high and some very low, which form the basis for the market and its performance movement along the spectrum. However, for much of the time, the movement of a security’s price in the market, along any price spectrum, remains quite stable, unless suddenly affected. This is where the concept of a trading range, an important feature of most security markets, gains ground.
A trading range is defined as the difference between consistent high (resistance) and low (support) prices in a given trading period. Put simply, it is the difference between the resistance price and the support price, within which spectrum the price is supposed to move in consistency. This difference characterizes the price movement in that period.
Trading ranges have their use in several aspects of trading applications. Range-bound trading refers to price movements within a definable range over a period of time. When trying to gauge an optimal strategy, investors often take not only a security’s trading range but also its duration into account. For example, day traders would typically look at the trading range in the first half of the day as a benchmark for their trades within the same day, especially during the second half, to determine their courses of action.
Naturally, since a trading range is consistent over a period of time, there are instances when prices can show significant deviations from such a consistency, resulting in a price momentum building up. When this momentum is positive, in which case it is termed a breakout, it results from security breaking through the resistance price. When the momentum is negative, in which case it is called a breakdown, it results from the security falling below the support price. Breakouts and breakdowns may be very small in scale, but they are usually more noticeable and reliable in the event of a large trading volume, which is characterized by expansive trader and investor participation.
What This Means
Given the link between price volatility and risk, a trading range may be viewed from a perspective of relative risk. Conservative investors would thus go for shorter price fluctuations, choosing to invest in stable (low beta) sectors, while liberal investors may go for greater price fluctuations, thus opting for cyclical (high beta) sectors.
Traders also use the trading range to make buy and sell decisions. This involves the examination of certain technical indicators, such as the relative strength index (RSI) or the commodity channel index (CCI), to determine whether a security is overbought (typically a higher index) or oversold (typically a lower index). Sometimes, market entry and exit decisions can be made in the direction of either a potential breakout or a potential breakdown from a given trading range, in which case price action and volume become crucial indicators.
As an example, consider the above graph. Here, the stock in question appears to have initially started building a price channel, which ultimately continues over time to yield two different consistent prices, one high and the other low, which would become the resistance and support respectively. Thus, for the period starting January 2018, 29.70 is the resistance price here, above which the price level does not generally rise. Similarly, 26.75 is the support price here, below which the price level does not generally fall. This suggests that a price rising above 29.70 would suggest a breakout, while a price falling lower than 26.75 would suggest a breakdown.