How to trade range breaks and breakouts

What is a range break, and how should you trade it?

What is a range break?

A range break is a movement of a market’s price above or below a previously unbroken level, for a given lookback period. This could be days, hours or minutes, depending on trading objectives.

A range forms during periods of market uncertainty, where no bias has formed and market makers buy and sell against each other at their theoretical best prices. When one side wins out, the balance tips and the price will shoot above or below the range.

This can happen following a quieter, lower volume Asia or London session in forex, before a news announcement in equities or other markets, or following a large move in any market.

Finding ranges to trade

Flags, pennants and other price action patterns are generally a heuristic for higher lows into stuck highs, or lower highs into stuck lows for the inverse. Ranges can also be perfectly parallel between key areas, narrowing towards the breakout or expanding, it’s really not so much a science as an art.

The general rule is that price is not trending, but bouncing off these sell and buy areas consistently. You can do things like check for volume on rejection of each area, to get a hint of where price may go, or zoom out to the daily/weekly to get an idea of what stage the market is in. Is this range a shelf in a wider trend, or is it the peak and accumulation phase following a strong move into a previous similar zone, that was also rejected?

Retests and opposing leg entries

The next thing to note is that trying to trade the breakout itself is risky, as it could be an expanding range that then reverts back to stop losses, way below the range.

Much safer to either:

a) Enter at the lower leg for expected breakouts to the upside b) Enter at a retest of the breakout level once breached

In both of these cases you can expect a much better risk:reward ratio, if the stoploss is kept tight. Price will invalidate your entry theory in a very short time if you are below the range or below the retest area, costing you a fraction of a full swing to the downside if you were to take the breakout itself.

The benefit of option (a) is that you get to exit potentially in profit or at breakeven if the range holds, despite not breaking out. Option (b) can still accelerate out of the last touch of the area, giving a similar situation to (a) but if it’s not a breakout, there is less chance of a “favourable excusion” as it is known, with price moving against you, or adversely (aka adverse excursion). Either way these are the sensible options for trading range breakouts.

Timed right, you can ride up to the next range with the price on a winning trade. This may however end up becoming a low win-rate strategy as you try to repeatedly time range breaks.

It may be wise to add a trend-following strategy to your entry methods to be able to trade all conditions. Then, it’s just a case of correctly identifying them each time. I’ve written about this here so you should be able to use that to start identifying them through indicators or PA if you can’t already.

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