Is a narrow range bullish or bearish? We look at the performance of stocks, bonds, and gold after a narrow range: a narrow range yesterday, here is what comes next.
What is a narrow range?
A narrow range in the market is a period of time (of your choice) when the price of a security or asset fluctuates within a relatively small range. This can be caused by several factors, such as low trading volume, uncertainty about the future, or a lack of new information. When the market participants have no new to digest, a narrow range is pretty normal.
Narrow ranges can occur in any market, but they are pretty common in the stock market. When a stock is trading in a narrow range, it might mean there is no clear consensus on the direction of the price. This can lead to a period of consolidation, where the price moves sideways for an extended period of time.
Some traders use narrow ranges as an opportunity to trade breakouts. A breakout is a situation where the price of a security moves outside of its recent trading range. Traders may believe that a breakout is a signal of a new trend and look to enter trades in the direction of the breakout.
- Opening Range Breakout Strategy- 5 minute ORB Trading System
- Breakout Channel Trading Strategy
- A Big (Huge) Trading Range Yesterday, Here Is What Comes Next
However, it is important to note that narrow ranges can also be a sign of indecision or uncertainty in the market. If a stock is trading in a narrow range for a long period of time, it may be difficult to predict which direction the price will move next. Only a backtest can provide you with any clue as to what is “normal” or not.
Here are some examples of narrow ranges in the market:
- A stock that trades between $100 and $102 for several days is normally considered to be in a narrow range.
- A currency pair that trades between 1.1000 and 1.1050 for several weeks is normally considered to be in a narrow range.
- A commodity such as oil that trades between $80 and $85 for several months is considered to be in a narrow range.
Narrow ranges can be a challenge for traders, but they can also be an opportunity to profit. It all depends. Traders who are able to identify narrow ranges and trade them successfully can generate significant returns.
Narrow range trading rules
We need to make trading rules to make a backtest. We make the following trading rules:
- We calculate a 25-day moving average of the High minus the Low.
- If today had a range (High minus the Low) that was lower than the 25-day average, we go long at the close and hold for N-days (one to five trading days).
The trading rules above are easy to backtest. If we backtest SPY, the ETF that tracks S&P 500, we get the following table:
The first column indicates the return for the first trading day, number two the second trading day, etc. The average gain for any random trading day is 0.04%, so the results are not that promising: stocks perform slightly worse than a random day after a narrow range day.
Let’s backtest TLT (long term Treasury bonds):
The average gain for any random day is 0.02% (for comparison). Thus, we can expect average gains in the coming days for bonds after a narrow range day.
Let’s finish this exercise by backtesting the gold price (GLD):
GLD has risen about 0.04% on any random since its inception. Thus, unlike stocks and bonds, gold has performed better than any random day after a narrow range day.