Many traders spend a good portion of time looking and waiting for trends in stock charts, hoping to ride the next wave to profit. However, for some, sideways price action can be just as lucrative. When a security ceases to follow a trend and instead oscillates between two prices, it becomes range-bound. As the price bounces back and forth, it establishes identical, or nearly identical, highs and lows, creating an upper resistance level and a lower support level. While the limited upside potential may be frustrating for someone looking to ride a trend, the relative predictability of these highs and lows can mean easy money, albeit in smaller quantities.
To effectively trade a range-bound stock, it is essential to first confirm the range. This means the price should have reached at least two similar highs and lows without breaking above or below at any point in between. Once the range, or price channel, is established, the simplest trading strategy is simply to buy near the support level and sell near resistance. Alternatively, when trading options, one could purchase calls near support and sell puts near resistance. Of course, especially in options trading, veteran traders sometimes use more complex strategies to play both sides of the bounce simultaneously.
Because the chief risk inherent in trading range-bound stocks is being on the wrong side of the breakout, it is important to pay close attention to any clues that might hint at when it will occur. Generally, a trading range is merely a pause before the continuation of a current trend or a period of indecision in the market before opposition forces a reversal. Therefore, while it is tempting to simply set a stop-limit order near the support or resistance levels and trust the pattern, it is crucial to pay attention to other indicators, such as trading volume, that may indicate an impending breakout. If the price breaks downward through the support level, a prematurely purchased call is quickly rendered worthless. A patient, conscientious trader can profit from the range and the breakout.