Narrow Range Breakout

This article written by David Pieper was originally published in the july 2014 issue of Traders' Magazine.

• David Pieper is a CIIA and has been interested in stock markets since the end of the Nineties. He concentrates on trading with CFDs and is a freelance author.

For private investors and traders who do not have time intraday but want to achieve high yields with active trading, the daily chart is ideal. The analysis and the placing of buy or sell orders can be done easily after the close of the stock exchange and therefore intraday live-monitoring is not necessary. Breakouts from below-average price ranges are especially good for entries. In the following article you will learn what is important and how to develop a trading strategy based on this knowledge.

The idea is very old but still relevant. The stock market often shows changes in volatility – calmer days and smaller trading ranges often follow days of bigger moves. The same goes vice versa: a dynamic move up or down often follows calmer days. Wellknown trader Toby Crabel introduced different trading strategies based on the so-called “Narrow-Range”.

(NR) days combined with the change in expansion and contraction of volatility in the early nineties. We want to continue this idea and use it to develop a trading strategy step by step.

Chart Setup and Entry Rules

We will start with the setup and the necessary indicators that will be explained shortly. The following setup is required to generate signals:

• Daily chart of a stock market index
  
• Moving Average of 250 days (MA250)
• Average True Range (ATR) of ten days (ATR10)

The pattern is known as “NR3”. It describes a daily candle with the lowest price range of the last three periods – the difference between high and low is measured. If such a candle appears, the breakout is traded the following day with a stopbuy order. Now the MA comes into play, which acts as a simple trend filter: If the market is above the MA250, we trade long signals only. The high of the NR3 candle is the stop-buy trigger. But if the index is below the MA250, we only enter short signals. The trigger is the low of the NR3 candle.

Exit Rules

Of course we need more than only entry rules – whether we achieve a profit or loss depends on the exit. There are two elements for the exit in this trading strategy: the simple ATR distance is the initial stop. Successful trades often reach the profit target directly and therefore confirm the trader’s idea. We want such trades to stay in the profit zone after reaching a certain book profit and therefore we add a break-even stop. The rule is: If the index increases by 0.5 per cent or more to the desired direction, the stop is placed at breakeven. Finally we add a profit target of twice the ATR.

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