Periods of low volatility have historically been known to accompany rangebound markets. Developing a range trading strategy can potentially provide trading opportunities even with low volatility.
The following steps can serve as a starting point as you explore a trading strategy to navigate rangebound markets:
Backtest Rangebound Markets
To get a sense of how a financial instrument behaves when exiting a rangebound market, you can backtest with volume, the Volatility Index (VIX) and other trading indicators on charting software.
Locate a Trading Range
Finding support and resistance levels within an established range is the next step in trading a rangebound market. Support is the area of a market range where a large amount of buying occurs creating a bottom in trading activity. Resistance is the area of a market range where a large amount of selling occurs creating a ceiling in trading activity.
Time Your Entry
The Volatility Index (VIX) can potentially be used as an indicator of change in market trend. A significant drop on the VIX may provide a signal for entering a rangebound market. Using a drop on the VIX as a trading indicator, you could potentially either buy or sell a financial instrument as either order can act as opening a position.
Know Your Exit Point
To help manage risk, traders may want to exit rangebound futures trading strategies when price action ‘breaks through’ support or resistance. A breach of support or resistance levels has historically signified an end to a rangebound market. If the breach is accompanied by a spike in the Volatility Index (VIX), an end to a rangebound market may be more likely.
The chart below of the S&P 500 Index (ES) and Volatility Index (VIX) during July – September of 2016 is an example of a rangebound market and potential exit point:
As always, remember past performance is not indicative of future results and you should always trade within your risk tolerance levels.