Trading In Sideways Market
Markets are often described in common parlance using animal spirits such as 'bull' or 'bear'. However, these adjectives can only be used for trending markets. Trending markets are those where prices show an upward or down trend. Any asset class will show some trending behavior at some time during their lives. There are markets that have relatively stable prices. These markets are called'sideways'.
Horizontal price movement is the most distinctive characteristic of a sideways marketplace. This means that price fluctuations are limited over a long time and occur within a narrow range. These markets have a sense of stability and certainty. Sideways markets are a completely different market. Each sideways market has its own set of peculiarities that may not be appealing to all traders.
You must be familiar with the market's characteristics and how to exploit them to your advantage in order to trade successfully in a sideways marketplace. These are some of the key features of a sideways marketplace:
- Defined range Sideways markets operate within a limited range that has clearly defined upper and lower levels (known respectively as resistance and support).
- Lesser gains: Due to the small difference between support and resistance prices, traders trading in these markets can expect narrow margins.
- More trading opportunities: A sideways market offers more predictability than a trending one.
- Perimeter design: To be successful in sideways markets, traders must clearly define their entry, exit, and stop-loss. Execution needs close supervision.
We now have a good idea of what a Sideways Market is and what features distinguish it from a Trending Market. Let's look at some key concepts that you should keep in mind as you learn how to trade in this market.
- Identifying a Sideways Market: When trading in sideways markets, the first thing you should do is to determine if it's a legitimate sideways marketplace. Sideways markets are defined as those in which prices fluctuate between upward and downward movements. This is mostly due to the market's indecision about the dynamics of a market.
It is relatively easy to spot a sideways market once it has formed. But it can be difficult to identify one as it consolidates. A series of short spikes within a narrow range is one sign that a sideways market may be coming.
- Draw the range. After identifying a sideways phase it is important to determine the upper and lower ranges. This can be done by looking at the constantly-changing support/resistance levels. To get a better understanding of your range, you can also examine trend lines.
- Determine internal levels. To minimize uncertainties, it is important to identify all resistance and support levels that could cause the price of the stock to hold. It is important to identify the middle range of consolidation phases in order to anticipate when prices will pivot.
- SpikesAnother way to be successful in sideways markets, is by anticipating breakouts in either direction. If traders are too comfortable 'riding the wave" in trending markets, they might miss the opportunity to call for quick exits when prices drop below a defined level. To avoid such situations, it is better to trade in a more conservative and safe manner.
There are many ways to deal with a sideways marketplace, in addition to the usual precautions. When it comes to securing gains and increasing their chances of growth, carefully curated options trading strategies can be a good choice. Here are some to consider:
- Short Straddle/Short strangle : These strategies are very similar and can be used to protect assets that won't move much over the term of their options contracts.
- A short straddle strategy involves selling both call and put options with the same expiration date and strike price. The maximum profit in such a situation is the premium earned from the option writing. This strategy is best for advanced traders as it can lead to unlimited losses.
- The short strangle is nearly the same as the long strangle, except that it uses out-of-the money (OTM), strikes for both the call or out options. This strategy is great for traders with tight budgets as it saves time and money.
- Ratio spreads - A neutral options strategy in which trades are structured so that there is a certain ratio between short and long positions.
- Ratio Bull Spread: This is a variant of a vertical spread and works best when there is a slight rise in asset prices. This involves selling two OTM options and buying an ATM call option. This allows you to pay a lower upfront cost and increases your risk-reward ratio.
- Ratio bear spread: This is a different version of the bull spread. It involves selling two OTM options and buying an ATM option. This is best for situations when the stock trades at higher levels and an expected correction.
All the strategies mentioned above work only when the sideways phase has been active. It is better to wait and save your capital if the market appears choppy. Trading in a choppy market can lead to over-trading and even losing money.