Understand the difference between trading range-bound stocks versus stocks in a trend.
Question: What do time travel and trading have in common?
Answer: In both cases, it’s critical to know what type of environment you’re entering.
Step out of your time machine into the Jurassic badlands, expecting 1950s New York City, and it’s going to be a long day. Try to trade a range-bound stock like a trending stock—or vice versa—and it might feel like you got chewed up by a T. rex.
And you don’t want to be eaten for lunch—not by the market, nor by a giant lizard—so perhaps it’s time to take a look at the difference between the two.
Just as the name implies, a range-bound stock is one that over time has moved between two (somewhat) fixed price levels, unable to rally above or break below. This type of movement is sometimes referred to as “basing” or forming a channel. A trending stock is one that may pull back or rest from time to time, but overall has been moving steadily at an angle—either upward or downward—and the steeper the angle, the stronger the trend.
Ranges and trends can occur in any time frame, and both will often coexist within a larger time frame. For example, if you look at a stock’s yearly chart, you may find that over that time frame the stock trended upward. But within that year there may be times when price was temporarily stuck in a range. This can also occur when looking at intraday moves, i.e., a stock can be trending on an hourly chart while stuck in a range on a 5-minute chart.
Some traders will trade both range-bound and trending stocks, but most have a particular preference. In general, range-bound trading is a more aggressive and intense style of trading, while trend trading is more passive. As a trader, you should determine which might be best for you based upon your temperament and the amount of time you can devote to watching the market.
Once you decide on a trading style, you’ll need to make sure you’re using the right tools for the job. For trending stocks, one of the most powerful is the moving average. To start with, a scan using moving averages, such as “stocks trading above their 200-day moving average,” can help you identify stocks that may be trending. Then you can tailor your strategy to the time frame you’re trading and identify potential entry points—such as when price pulls back and touches the moving average line.
For stocks trading in a range, the goal may be to find entry points as price turns up from support levels and then exit as price hits resistance. For that, you may want to focus instead on oscillators—indicators that are designed to show overbought and oversold levels for a stock within a selected time frame. Oscillators include the moving average convergence/divergence (MACD), Relative Strength Index (RSI), and stochastics.
Although individual stocks can move independently of the overall market, traders feel it’s usually best to marry your style to what’s happening on a macro level. If the indexes are in a choppy, range-bound period, and you are a trend trader, you may want to focus exclusively on short-term trends, or perhaps just step aside until the market returns to a trending environment. If you prefer to trade range-bound stocks, when the market as a whole is trending, you may be more likely to get stopped out of your trades.
There is no right way to trade stocks. Just remember the three Ts—temperament, time frame, and tools—and choose the style that fits your temperament, the time frame you prefer, and the tools you’re most comfortable using.
A timeless suggestion? Perhaps.
While this article discusses technical analysis, other approaches, including fundamental analysis, may assert very different views.
Stock trading is subject to significant risks, including loss of principal.
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