Identify range bound markets on Daily or 4 Hour Charts
A ranging market is simple to identify. We are looking for clearly defined sideways movement that is sustained with several tops and bottoms.
Used a 20 and 50 EMA to show how moving averages can also signal a ranging market as they quickly begin to flatten and intertwine with one another. This is, of course, a lagging indicator but for those of you who like indicator confirmations, moving averages are an easy way to confirm a ranging market.
Step 2:
Identify an Over Extension within a Dead Market
More often than not, extended steep moves will pull back to settle toward reasonable prices, but
this is even more true when the market is in a defined range. When it begins to accelerate and
get overbought or oversold we are very likely to see it “snap back” like a rubber band once the it
runs out of orders to fulfill.
As always, I like to use multiple time frames to get a complete, accurate view of the market, so
once we have a ranging 4 hour or Daily market condition, we’ll zoom into a 60 minute chart to
find an over extended point within the market.
On the 60 minute chart, we’ll add a Bollinger Band (standard settings) and RSI (standard). The Bollinger Bands and RSI give us a double confirmation to find overextended conditions.
Bollinger Bands are a great indicator for this because they shrink down and quickly define a range which, in turn, makes it obvious when the market is stretching out of that range. When you combine the defined ranges with stretched Bollinger Bands, you get a pretty good idea of when price might make a turn around. But we also like to use the RSI to make sure that price is clearly overbought or oversold.
**Please Note: The RSI is NOT an entry signal. It simply helps our patience and discipline as
we are forced to confirm an overbought or oversold condition before going to the next step.
The Bollinger Band and RSI are what allows us to be certain that the market has stretched like a Rubber Band and is ready for a potential snap back in the opposite direction. Now we know that the market is in position for our Rubber Band Reversal, but we do not have the ability to enter the trade yet.
This is where a LOT of traders get tripped up. The see the RSI shoot over 65 or 70 and they are too trigger happy they just begin shorting the market. The problem is that more often than not, when the market hits 65 or 70 it is still in a momentum phase and we simply don’t know how long that momentum will last. We do not know how far the rubber band is going to stretch. We wait for the price to pierce the upper Bollinger band and simultaneously, we want RSI levels to be above 65 levels. After both conditions are met (Bollinger Band pierced and RSI overbought /oversold) we can go to Step 3.
Step 3: Find an Entry
To find a high probability entry, we look for a unique combination I have used for a long time. The combination is a 15 Minute Reversal Candlestick (pin bar, inside bar, engulfing, etc.) at a whole number. Whole numbers are important because of their psychological value.
Step 4: Execution, Stop Loss and Take Profit
Once the entry is made, we can place the Stop Loss a few ticks below the entry candle or previous candle (whichever has a higher high) and we can place our Take Profit at the midband
of the Bollinger Bands.
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