The price on the trading chart is always moving. It sometimes goes up, sometimes down or sideways. When to trade and when is it better to avoid entering the market? Let’s learn something about trending and ranging markets today.
Key Takeaways🔑
| →Identifying the market phase, trending or ranging, is crucial for effective trading. |
| →Indicators like EMA and ADX can help identify the market phase. |
| →Diversifying the asset portfolio can help navigate through the ranging market phase. |
Contents
The phases of the market
Generally, we can indicate two market phases, the trending and the ranging ones. The trending stage we can further divide according to the price direction and so we have the uptrend and the downtrend. The uptrend can be identified when the price of the underlying asset is making higher highs and higher lows. The downtrend occurs when the lower highs and lower lows are formed. Note, that although the price is moving upwards or downwards it occasionally retraces and pulls back. So do not expect constant rise or fall. Nevertheless, if the higher highs and higher lows are visible, you should assume the market is in the uptrend and with lower lows and lower highs in the downtrend. Trending markets are the ones you like to open your transactions on. But what about the range?
The ranging phase can be identified when the price is making random highs and lows. Some say that it fluctuates within a certain range. It is better, however, to check whether there are higher highs and lows or lower highs and lows. You can also use some indicators to help you recognise the ranging phase. It is useful as you should avoid entering the market on these occasions.
Identifying the ranging phase in the markets
There are many ways in which you can tell whether the market is in the ranging phase. Here, I propose using the Exponential Moving Average or the Average Directional Index.
Using the EMA to identify a ranging market
Add the Exponential Moving Average to your chart by clicking the indicators icon and then its name on the list. The period of the EMA should be set at 200.
You can use the EMA in two manners. One is just by observing its line moving over the candle bars. The market is trending when the EMA’s slope is powerful. The more significant slope, the stronger the trend. The market is in the range phase when the line of the indicator shows just slight up and down activities remaining rather flat.
Another way of using EMA to detect the market phase is by observing the distance between its line and the price bars. The EMA200 and the candlesticks are far apart in the trending markets. Sometimes they arrive closer to each other but then you should pay attention to whether they cross and stay close for a longer period of time or they rather get nearer just to push further away. The range can be recognised when the EMA200 and the price bars stay close together for a while.
Utilizing the ADX to recognise a ranging market
The Average Directional Index can be added to your chart the same way the EMA was. So click on the indicators icon, find the indicator’s name on the list and click on it. This indicator, however, appears below the chart in a separate window. Leave the settings as default.
There are a few lines of ADX. You should watch the mainline and the values around which it plots. If it moves above a particular value, the market is in the trending stage. If it is situated below this value, the market is ranging.
You probably want to ask what value it is. Regardless, I do not have one good answer to that. Usually, the numbers are 20, 25 or 30. But they may vary for different assets and it is your task to estimate a specific value for the instrument you are currently trading.
Pros and Cons of Identifying Market Phases 👍👎
Pros:
- Enhances strategic planning for trading
- Optimizes the potential for returns during trending phases
- Reduces potential losses by avoiding ranging phases
Cons:
- May require advanced understanding and experience to interpret indicators accurately
- Potential for error if the market suddenly shifts from its current phase
- Dependence on external indicators which may not always be accurate
| Indicator | Function |
|---|---|
| Exponential Moving Average (EMA) | Identifies trend direction and strength |
| Average Directional Index (ADX) | Detects the strength of a trend and whether the market is ranging or not |
Conclusion
One of the main trader’s tasks is being able to identify what phase the market is in. You want to enter trades in the trending phase and it is advisable to avoid ranging markets.
Use the help of the indicators to recognise the ranging phase. Apply the EMA200 or the ADX to your chart and observe how they move.
And what to do when the market goes into the ranging phase? You should be ready for this by choosing more than one instrument. If you focus just on one asset, then, in the event of the range, you are stuck. But when your interests are wider, you just move to another instrument and still are able to perform trading.
Good luck!
Q&A on Market Phases and Trading Strategy 🎯
- Q: How does identifying market phases improve trading?
- A: It allows traders to plan their strategies according to the prevailing trend, optimizing their potential for returns and minimizing losses.
- Q: How can the EMA200 help recognize a ranging market?
- A: If the EMA line stays close to the price bars for a significant period, it indicates a ranging market.
- Q: How does the ADX indicator work?
- A: ADX measures the strength of a trend. If the ADX line stays below a particular value (often 20, 25, or 30), it signifies a ranging market.
- Q: What should a trader do during the ranging market phase?
- A: It is generally advised to avoid trading in a ranging market. Traders can focus on other assets in their portfolio during this phase.
- Q: How important is diversification in trading?
- A: Diversification can provide more trading opportunities, especially when some assets are in the ranging phase.