How to Determine the Meaning of a Changing Trading Range
The length of the price bar, the trading range, is the difference between the high and the low. When conditions change, the average trading range is sometimes the first aspect of price behavior to change.
A change in the high-low range usually precedes or accompanies a change in the direction or slope of a trend. Take note — it’s often a leading indicator:
Range expansion: A lengthening of the price bars over time — the high-low range is getting wider — and usually suggests a continuation pattern.
Range contraction: A shortening of the price bars — the high-low range is getting narrower — and suggests that a trend reversal may be coming soon.
A change in the size of the bars — range expansion or contraction — doesn’t tell you anything about the existing direction of the price move. The range can expand or contract in both uptrends or downtrends.
As a general rule, an expanding range is a continuation pattern and a contracting range suggests that a trend reversal is impending. Sometimes your only clue to a shift in market sentiment about your security is a change in the high-low range, but check for these confirming conditions, as well:
Volume: Look to see whether the volume is rising or shrinking:
Rising volume: More people are trading the security, or existing traders are taking bigger positions. This rising volume usually accompanies range expansion and is an excellent indication of an accelerating trend. The acceleration can be in either direction, up or down. If you see an expansion of the range and it fails to have an accompanying rise in volume, you have a mystery and need to look at some other indicators, such as momentum.
Shrinking volume: Fewer people are in the market for this security, or existing traders are reducing their allocations to this security. Falling volume often accompanies range contraction.
Open-close position: Here’s an outline of the four possible open-close combos and what they likely mean:
Expanding range, higher closes: Buyers are excited about the prospect of the price going higher still.
Expanding range, lower closes: Sellers are ever more anxious to unload the security.
Contracting range, higher closes: In all range contractions, traders start to feel uneasy about the direction that the security has been trending. But a higher close can offset some of the negative sentiment inherent in a contracting range.
Contracting range, lower closes: This combination is doubly negative. Traders may not be causing lower lows, but they are unloading at or near the close, forcing it lower. Range contraction usually means that activity is drying up and volume is low — so if you see high volume and a lower close in a contracting range, you probably want to get out of Dodge (exit the security).