Range is formed when the market consolidates. Most of the time the market is moving sideways or consolidating between two horizontal levels that are known as the support and the resistance. When the market is confined between these two horizontal levels, it is said that it is range bound.
A market cannot stay in a range for a long time. Invariably, it will come out of a range. When it breaks the range, a new trend starts in the market. Trading range breakouts is an important trading strategy that tries to capitalize on these breakouts in the up or the down direction.
How To Identify True Range Breakouts?
Ranges are easy to spot as price action will be confined between two horizontal levels called the support and the resistance. There are a number of important chart patterns like the Head and shoulder as well as double tops and double bottoms that are considered to be important range breakout patterns. When you identify the range make sure that it either lies near the swing high or low of the previous day.
A classic range breakout strategy is to place a buy order above the resistance and sell order below the support of the range and the stop loss at the middle of the range. Placing the stop loss at the middle of the range will give you a risk to reward of 1/2. Another strategy is for the price action to breakout of the range on either the up or the down side and then make a pullback. So, you enter near the pullback and place the stop loss near the lowest point of the pullback. The idea behind this range breakout strategy is that after a breakout the price action tends to make a retracement and after that again starts to move in the direction of the breakout. This pullback is used as a filter to distinguish a false breakout from a true breakout.
As a Novice Trader Don’t Trade Range Breakouts
However, trading these range breakouts for a new trader is not a profitable venture due to the presence of the false breakouts. When the price action breaks out of a range, the chances of it making a retracement are high. These retracements turn the unrealized profits into losses. Many new traders don’t know how to distinguish between true breakouts and false breakouts. Another problem with trading range breakouts is that if the range is narrow, you won’t be able to make many pips.