Seasonally, November is typically a time when stock markets tend to outperform. The biggest one day gains since 2020 this week are a promising sign this November could live up to its reputation. But it’s good to have a backup plan.
On the back of the losses across many stock markets over recent months, traders are now starting to question whether the so-called ‘Santa rally’ (gains over the Christmas to New Year period in the stock market) will materialise.
Furthermore, if it doesn’t, then what is the best way to approach the markets especially if we slip into sideways action? One approach is to look for opportunities in other markets and while this can work, we don’t always find what we’re looking for.
Away from stock markets, we’re seeing concerning price action in the crypto space too. The massive volatility which drew in so much interest in 2020 and 2021 has dried up this year and flipped into a cycle of sideways action followed by sell-offs. Just this week, there was a huge liquidation of crypto positions linked to collateral problems at the crypto exchange FTX.
So, with this in mind, it’s important to learn how to deal with sideways markets. Fast-moving, trending markets with long directional pushes are fantastic and when you have the correct strategies in place it can seem very straightforward to profit from those conditions. However, it’s worth remembering that markets tend to only trend around 20% of the time and are actually in choppy, side-ways conditions for around 80% of the time, so it makes sense to brush up on some strategies to capitalise in sideways markets.
Three Sideways Market Trading Strategies
- Fading Support/Resistance
- RSI Indicator With Support/Resistance
- Fading Bollinger Band Levels
1. Fading Support/Resistance
The first and most simple method of trading sideways markets is looking to fade support and resistance. So, if we identify a sideways market as a period of price action where the price is essentially trading in a range, we can look to sell as price tests the resistance level and look to buy as price tests support. This “fading the range” strategy can be employed on any time frame and can either be executed very crudely, simply buying or selling as the price touches the marked level or in conjunction with price action trading where you wait for a reversal candle to form at the level.
Trading Example
Source: FlowBank / TradingView
In the example above you can see that price was moving sharply lower initially before stalling out and reversing higher. From this point, we have our initial lows which formed after a bearish phase. With price failing to break those lows and failing to break above the initial correction highs, we can see that we settle into sideways action. As such, once we have marked up our horizontal support and resistance levels we can then look to buy as price tests support, trading the reversal higher and sell as price tests resistance, trading the reversal lower.
Using Technical Indicators
Another method for trading sideways markets is to incorporate indicators with the above market structure basics. Once we have identified our support and resistance levels, we can look to use technical indicators to help strengthen our bias for taking a trade. There are many different indicators we can use when trading sideways markets. Typically, however, momentum studies tend to be the most useful for fading trading ranges. One in particular that works well is the RSI indicator.
RSI Indicator With Support/Resistance
The RSI indicator is a tool which measures the strength of price moves and identifies them as either overbought (and vulnerable to a reversal lower) or oversold (and vulnerable to a reversal higher). So, if we think about the methods we just discussed, ideally the way we would look to use the indicator is by checking it each time price tests our horizontal levels and looking to see if we get a trading signal. So, for a bullish trade, we want to see price testing the support level and the RSI indicator touching the oversold threshold (which tells us price is vulnerable to a reversal higher) or price testing the resistance level and price touching the overbought threshold (which tells us price is vulnerable to a reversal lower).
Trading Example
Source: FlowBank / TradingView
So, looking at the above chart we can see our RSI indicator in the sub-panel below the price chart. Highlighted are the two instances where the indicator gave overbought/oversold readings in line with price testing resistance/support, giving us the go-ahead to trade the reversal.
Key Points
Now, the noteworthy thing about this method is that you can see there were other times when the price tested the resistance/support levels and reversed but as there was no accompanying RSI signal, there was no trade. So, it’s worth pointing out that when you trade in this manner, you will certainly get fewer signals, purely because you’ve added in an extra element of criteria for taking a trade. However, you should find over time that this means the signals you take tend to perform better than if you are just trading the level strikes without any extra confirmation.
Fading Bollinger Band Levels
The last method I want to look at then, utilises another technical indicator, the Bollinger bands. This indicator is a fantastic tool for trading sideways markets. The indicator charts a 20-period moving average (can be customised) with an upper and lower limit marking two standard deviations above the average and below the average. Essentially the premise is that (in flat markets particularly) when the price hits either limit it is likely to reverse and trade back to the mean, the moving average. So, this gives us the opportunity to fade the level much in the same way we looked at fading support and resistance in the first method we discussed. This time, however, the levels are plotted by the indicator.
Trading Example
Source: FlowBank / TradingView
Looking at the above chart we can see a great example of this method in action. So initially, note how the bands are pointed lower, reflecting the bearish trend with the price pushing lower beneath the moving average. However, after the gap lower, the trend loses momentum and the price starts to consolidate and move sideways, reflected by the flattening of the bands. Once we see the bands turn flat like this we can start looking for prices to test the upper and lower limits to give us opportunities to fade the reversal back into the middle of the range. The beauty of this method is that the indicator plots the levels for you but they can also be combined with your own marked-up price levels for added confirmation.
Final Thoughts
Hopefully now the next time the markets lose momentum and trending price action turns into sideways price action you’ll be feeling excited to try some of these methods out. As with all good strategies, they can be employed in any timeframe and in all asset classes so spend some time applying them to your favourite trading instruments and see how you get on. Finally, remember to always manage your risk and trade responsibly for the best long-term results.
