When an instrument starts trading within two levels of support and resistance and it finds difficulty breaking either of the two levels, it becomes boxed within those zones and goes into a consolidation. These ranges could be relatively small, maybe 50 or less pips on the lower time frames, but they could also be wide like the 400 pip range that we are seeing on the Daily chart of the USD/CAD, courtesy of the Forex Broker ActivTrades http://www.activtrades.co.uk/.
If we take a look, we can see that the support has been around the 1.2400 level and the resistance around the 1.2800 level. The middle of the range is the 1.2600 level and we can tell from the chart that the price has also found that level to be a temporary support or resistance zone.
The general theory when trading within a range is that short or sell positions are taken on the resistance and long or buy positions on the support, but this is easier said than done, because first of all, we cannot be so sure about the range until the price has already tested the upper and lower boundaries a couple of times and the consolidation becomes clear.
The risk of taking short positions at the resistance and long positions at the support is that at any moment the price may break that resistance or that support and we may get stuck with a position on the opposite direction of the breakout. This is what makes range trading more difficult. That is why when trading within a range, we must be aware of the risks involved and we should accommodate our stop loss to a level that does not represent a huge loss to our account. Remember that usually when the price breaks out of these ranges, it tends to accelerate its momentum in the direction of the breakout and it may be not very wise to trade against that momentum or speed.
Alexander Londono – Analyst Contributor at ActivTrades.