The “Big Three” Indicator Combo for Trading Range Days
08/15/2012 2:15 pm EST
For intraday traders, especially of equity index futures or related ETFs, adapting to the intraday volatility environment can be a major factor in a successful trading day. Different days call for different tactics, as certain trade set-ups–and indicators–perform better either in a low volatility range or high volatility trend session. Let’s focus on the “Big Three” indicators that combine to trigger the best trades on a low volatility “Range Day” session.
Range Days often develop when there is no overnight news, no pre-market economic report or announcement, and no major opening gap above or beneath the prior session’s close. If nothing is out of the ordinary as we start the current trading day, then we may expect the remainder of the session to develop into a low-volatility, range-bound session.
In addition to noting the prior session’s price high and low along with any intraday price trendlines that develop, we’ll focus our attention on three main indicators to create trades:
- Bollinger Bands (plots two standard deviations above and beneath a 20 period moving average)
- Reversal Candles (classic doji, hammer/shooting star, spinning tops, bullish/bearish engulfing)
- Market Internal or Momentum Divergences (a negative divergence occurs when price registers a new swing or intraday high while the indicator registers a visual lower high)
By combining these indicators, the perfect “Range Day Fade Trade” develops when price declines to the lower Bollinger Band (or prior price support trendline) on a five-minute intraday chart as a bullish reversal candle develops. If we also view the one-minute intraday chart, we can clearly see a visual positive momentum (using the Rate of Change or 3/10 MACD Indicator) or market internal (TICK or Breadth) divergence. The same logic would apply to a bearish or short-sell ‘fade’ trade at an upper resistance level.
Figure 1: SPY 5-min Chart on July 9, 2012. After a morning sell-off, a visual range then developed. “Fade” Trades 1 – 3 highlight reversal candles at Bollinger Band extremes. (Created with TradeStation)
Figure 2: SPY 1-min Chart for July 9, 2012.Dropping to the 1-minute chart, we see positive or negative divergences using the Rate of Change and NYSE TICK (Market Internal) indicators. Combine the 5-min “Bollinger Reversal Candles” with 1-min corresponding indicator divergences, all of which increase the odds of a successful trade. (Created with TradeStation).
For entry and management tactics, a trader would look to buy as price breaks above the high of the reversal candle on a five-minute chart, placing a stop comfortably beneath the expected price swing low or support trendline, and hold the trade until price rallies to the upper Bollinger Band or resistance trendline for an exit target. A trader would then assess whether to play a short-sell fade trade if a new bearish reversal candle or negative divergence develops and manage the trade similarly (targeting the lower Bollinger Band). Traders would abandon this range-based ‘fade’ strategy should price instead breakout of the established intraday range.