What is a Range-Bound Market?

It is obvious, from the statistics available, that we are stuck in a range-bound market! There are several strategies to be considered in this situation…..these are discussed in detail further in the article.

The market has been anything but predictable over the past month. Stocks have been up one week, and then crashed the next. And many investors wonder if the indices will collapse again or rise to fresh highs.

A range-bound market is observed as a trading strategy that identifies stocks trading in channels. By finding major support and resistance levels with technical analysis, a range-bound trader buys stocks at the lower level of support (bottom of the channel) and sells them near resistance (top of the channel).

Check out the two charts below, the S&P 500 and the Nasdaq, clearly outlining the range-bound market areas of late!

S&P500-range-bound-sept-2011



nasdaq-range-bound-sept-2011

The U.S. economy is weakening, and investors aren’t prepared for that news. Just look at the market’s free fall last week after Chairman Ben Bernanke said the Fed sees “significant downside risks to the economic outlook.”

There is a great deal of doubt that the Federal Reserve’s so-called ”Operation Twist” will bring back the buyers. Warning signs are coming through loud and clear that the trend is down. That said, investors don’t have to sit idly, waiting for better days.

One area that needs to be considered, is finding the best trading strategies for the range-bound market that we are experiencing.

It’s been estimated that stocks spend as much as 80% of the time doing absolutely nothing. And that means most of the time your investment money is just sitting there, trapped between short-term support and resistance.

The present range-bound market represents the typical trading strategy characteristics, with the top of the trading range being called the resistance, because it is known as the price limit within the current trading range: and, the bottom level is called the support, which is the lowest price that a stock has recently traded at.

range-bound-support-resistance

The resistance is the highest price that buyers have recently paid. Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further.

The logic dictates that as the price advances towards resistance, sellers become more inclined to sell, and buyers become less inclined to buy. By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance. If resistance is ever passed, technicians see that as an indication that the price may rise further.

Conversely, in a range-bound market, support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy, and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support. If a stock’s price falls below current support, it may signal a declining trend to a lower trading range.

range-bound-market-trending-down

Recognition of key support and resistance levels is essential for successful technical analysis. Although it is sometimes difficult to establish exact support and resistance levels, being aware of their existence can greatly improve analysis and forecasting power. Channel or trading ranges play an important role in determining support and resistance as turning points or as continuation patterns.

Strategies to Employ in the face of a Range-Bound Market

As discussed in an earlier article, ”Volatility Survival”, I outlined some strategies for the near-term future. Here are some added viable moves that you can do today which will help you prepare for and take advantage of the market’s inevitable volatility.

These are, as mentioned, further range-bound market strategies that we can employ:-

1. One that S.O.M.E. (Stock Options Made Easy) employs continuously is“trading options”.

• There are many methods that stock options can be used – the simplest is buying calls and puts. In this range-bound market, a top and bottom can easily be recognized – therefore, making it easier when to exit the trade.

• You can also eliminate the need to forecast whether a stock is going to move up or down. You can use direction neutral stock option trading, such as straddle trading, to generate income if the stock moves either up or down. The risk in these trades is limited to your initial cost.

An example of a “credit spread”

You want to produce income from options using the gold ETF SPDR Gold Shares (NYSE: GLD). If you believe gold will go down in price, you can execute what’s known as a “credit spread”:

Sell to open the GLD Oct 174 calls

Buy the GLD Oct 176 calls That gives you 22 cents net credit. One options contract trades 100 shares, so your credit would be $22 for this specific trade.

Gold can go up – and you’ll still make money.

You are not required to have a precise direction on the market. No crystal ball necessary. In fact, you can make money on a trade even if GLD moves in the opposite direction of your belief as long as it does not exceed your short strike at expiration. In this example, it would be the $174.22 strike.

If you believe gold will go up in price, you can execute a similar credit spread buying and selling out of the money puts to similar effect.

• Sometimes you can even setup some direction neutral stock option trades at no cost.

• Stock options can also be used to reduce your risk in stock ownership. If you own a stock that is not moving, something that most stocks do about 80% of the time, you can sell a call option against it at a strike price higher than your stock cost.

2. Raise cash

Cash is king in today’s uncertain environment, however, heed the advice from the article ”Volatility Survival”, stay in the game and “PLAN”. The cash definitely provides the safety of a good night’s sleep as well as the flexibility to take advantage of opportunities in the future.

Sure, those near-0% interest rates at banks don’t look very appetizing, and human nature being what it is, we have trouble selling stocks after prices have already fallen. But it’s easier on the psyche to raise some cash today — sell some stocks, curb some spending, go after that raise — in the hopes of putting it to use tomorrow. And in this range-bound market there will be plenty of opportunities for the prudent investor.

3. Look for income-generating stocks

Blue-chip stocks with hefty dividend yields are the comfort foods of the stock market. The older giants of industry can provide safety today and cash tomorrow. There are many quality names out there with great businesses and attractive yields.

Here are three:

• Waste Management does a dirty job for millions of folks. The market may go up or down, but the company will be there every day to haul away the trash. Its services are always in demand and its 4.4% dividend yield is very attractive.

• Intel is the largest chip maker in the world. If you’ve got a computer, chances are that Intel made the chips to run it. The company has a strong business, a great balance sheet, and a huge desire to share the spoils with shareholders. Today, its stock yields a fantastic 3.8%.

• Johnson & Johnson touches our lives every day. Have a cut? It supplies the Band-Aid. Got a migraine? It makes Axert. Need a strong company with a healthy dividend for your portfolio? Johnson & Johnson pays a 3.7% dividend yield.

These companies are strong and their dividends will continue to grow. Their solid foundation and income streams can dampen ups and downs, making the ride a little smoother.

4. Look for companies with huge long-term growth potential

While blue chips can help portfolios get through near-term rough patches, it’s young companies with huge potential that can generate incredible long-term returns — if you can ignore the ups and downs and focus on owning the business.

For instance, SandRidge Energy an oil and gas exploration and production company, looks like a long-term winner. It’s made all the right moves recently, shifting its focus from natural gas to acquiring oil rights and drilling new oil wells. Selling oil should generate higher returns relative to natural gas, positioning the company perfectly for the next decade. Investors who can think 10 years down the road, versus 10 weeks, should be amply rewarded.

Be Prepared – Plan Ahead of the Range-bound Market

The signs point to rough sailing in the market’s waters. So we have to be prepared.

Always have a plan, such as in any great business, a plan is essential for success, therefore your investment into the market to be profitable is also your business—“Plan Ahead”– and stick to it where possible.

–“Discipline never goes out of style.”

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