When stripped back to its core, markets are either trending or ranging. How we detect that, manually or through calculations, soon becomes an important question for all traders. In this post we discuss the top methods used to screen various instruments and assets for which regime or phase they are currently in.
What is trending or ranging?
In all markets, at their core, price is based on supply and demand. When there is a bias, up or down, long or short, we say the market is trending. When there is a balance, with no clear bias, the market is ranging. Other terms for this include consolidating, balanced or accumulating markets. They all refer to the same thing. These are pretty much the only two states the market can be in, albeit to varying degrees.
It should also be kept in mind that a range on the daily chart might present several trends to the M5, M15 or even H1 traders, depending on their point of view. Likewise the daily, D1 range might be part of a weekly or monthly trend that is ongoing on higher timeframes. Some refer to this as the markets being “fractal”. In practice, what this means is that you generally have fewer opportunities on the higher timeframes than on the lower. Those on higher timeframes typically being better confirmed and less “noisy” than those on lower timeframes.
For intraday traders, those who typically close out all trades by end of the day, the hourly and below are most common for entries, with higher timeframes used for trend or bias information. So when we talk about trends and ranges, it’s typically from this shorter term perspective, but can apply over all points of view.
As alluded to above, you can also have weakly trending markets, where a slight upward bias can persist for many hours or days without ever breaking out with any momentum. This is similar to a range, but there is an inherent bias one way or the other on higher timeframes.
Most traders typically like to understand what regime the market is currently in, in order to make the most of trading opportunities.
Why do we want to know if the market is sideways or breaking out?
This information is useful because range-bound markets tend to revert to their mean, often from sometimes obvious support and resistance levels. This can be on the H1 chart, a trend ending and slowly rolling over at a key resistance level, or on the M5 chart showing no ability to move higher and break the resistance above.
Trending markets are traditionally approached by buying dips in the trend, such as bounces off an MA or dips in an oscillator. If you know the market is not going sideways, you can apply this method to your entries.
For automated or semi-automated trading, identifying range or trend markets is key to getting the right kind of entry. While many indicators lag, and many support/resistance zones fail, with enough consistency and solid risk management you can put probability back on your side.
Finally, it is also worth noting that mean reversion trades can be converted to longer trend trades, but trend trades cannot be made into mean reversion trades. Meaning that you can pick a great, tight entry on a reversion in a range and then hold onto it if it breaks out of the range, but you can’t reverse a trend trade if it is incorrect, only hold through a much more permissive amount of drawdown to check your entry wasn’t too soon. If you buy dips in trends, however, rather than breakouts, you can have much tighter entries that are more similar to mean reversion or range trading entries. This will be good for your Risk:Reward ratio, improving your odds of longterm success.
In sum, if you want to have the best entries, look at ranging/reverting areas first, opening the option for trend following on the 1 in 10 or 1 in 25 that allow you to.
Top ranging and trending indicators
The Average Directional Index is calculated from the absolute difference between the average of the upwards movement and the average of downwards movements.
The rule of thumb typically used is if ADX is over 25 it is trending, under means ranging. It is available on every trading platform.
Needs to be used in conjunction with support and resistance levels, or similar, to pinpoint likely reversal points within the ranging period. Essentially you can use it to start looking for reversals, but not rely on it for entries itself.
Pros: Nice rule of thumb, easy to understand Cons: Waiting for it to break above 25 often loses you half the trend, so must be used with technical levels
ATR below MA
If you plot an MA over the ATR line (drag and drop in MT4/5, > “use first indicator data”) you can soon see similar correlations to the ADX lines, where lack of volatility and range-bound behaviour is found when the ATR is under its moving average, while trending typically occurs when above.
Try an MA of 20 initially, that ought to be reactive enough while retaining its smoothness.
Same caveats apply as above.
Volume under MA (free to study indicator available)
You will often find a drop in volume around reversal areas. This is a subject of a post of its own.
Temporary volume increases suggest volatility, sustained increases suggest a trend may be developing. Likewise sustained drops in volume suggest a balance and/or lack of participation in the market, typically resulting in ranging behaviours.
I have a volume studies indicator that is free to download and use for MT5 if you would like to see where volume is compared to its average, when a bar doubles or halves previous volume bars or when volume is double/half the average.
Oscillators in middle
Oscillators such as the RSI, stochastic, CCI - these can all show ranges when price is sat between their extreme levels. The
This indicator is another whole post, or book, of its own. It can be a complete system in itself. But suffice to say the shifted MAs give price time to “prove” that it is rolling over and not just pulling back, i.e. it typically shows clear trend changes, with price in the “cloud” between shifted MAs before changing direction.
Pros: Very clear to read Cons: Can still be consolidation before continuing the trend
MA stacking (see free indicator)
Stacked MAs are another way to tell if price is rotating or ranging, as they are close together, or starting to widen, indicating a trend underway. Try plotting a 10 period EMA, a 50 and a 100, or some combination that increases and you’ll see how they act. I made an indi to measure their width and display it in an easy to read format, see below.
This stacked MA indicator is also free to download and use, again for MT5, with the MA width line showing ranges near the centreline and trends when at its extreme.
Between bands or channels - Donchian, Keltner, Darvas, Bollinger
Channels and bands show when price is beyond or within a running average range.
If you take Bollinger as an example, prices within the bands are said to be ranging, outside of the bands you are either starting a new trend or experiencing a volatile range. Depending on surrounding key levels, price action and fundamental information you can determine which and trade accordingly. Volatility is also indicated by band width, even if this can lag large moves by a sizeable amount.
Donchian channels were favoured by the famous Turtle Traders, who repeatedly bought breakouts until one stuck. Darvas boxes were a similar concept created by a dancer turned millionaire trader, letting you know when price is breaking out or a range in a similar fashion. Keltner channels use the ATR, average true range, of a set period, to show you the likely width of a range on the chart around a moving average. All useful indications of whether price is within a range or outside of it.
Pro-tip: shift your channels 2 bars to see breakouts earlier.
Price action, support and resistance levels
This is the art of drawing your own channels, zones and levels around the price to determine best spots for entry. At its best it does away with all of the above and its users can use candle shapes and patterns to determine where price is turning and where it is likely to turn.
The downside is the heavy manual involvement, which is not great for semi-auto or fully automated trading. The indicators give us proxies to the human-readable price action and tend to work best when the humans can read charts well in conjunction with their data.
If you combine manual and semi-auto/auto risk management, you may be getting the best of both worlds.
Bonus indicator: one that automatically adjusts to market conditions
The Strength Diff indicator I’ve developed uses a smoothed and normalized scale, meaning ranges and trends are handled gracefully by the indicator as it adjusts in real-time to conditions as they unfold.
In practice this means that a 10 pip range will still show extremes of strength in two currencies (strong USD vs weak GBP) and highlight this as clearly as a 200 pip range at extremes.
Coupled with automated detection of key levels, I’ve also made this into a semi-automated trading bot for all forex pairs and Gold. More on that to come!
There is also a scalping version for if you’re doing away with levels and targets and taking what each move can give you. You check the entry makes sense and the bot will set SL and exit for you in profit, at breakeven or SL if the unexpected does occur. Also changes in strength.
While range or trend determination can be seen as more art than science, it’s clear that there are a range of tools available to at least hint at where the market is in terms of balance. These coupled with manual chart analysis and careful risk management can lead to a more complete understanding of how markets m ove.
There is an accompanying Youtube video to come, where I go through a few examples of each, including my own indis as set out above.
Thanks for reading. Share it with your networks where it makes sense.
EDIT: I will be back to update this post with screenshots and more detail at a later date!