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Application of Range Expansion Reversal Strategy in Trading

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Have you ever thought about the daily range of a currency pair? If you have been trading for some time, you know that currency pairs tend to reach the extent of their daily range at some point in the New York session. The truth is that with a bit of technical analysis, a trader can oftentimes determine the general area where a currency pair will be exhausting its daily move, reversing, and trading back into its daily range. This simple, but powerful trading scenario is the backbone of the range expansion reversal strategy. In this article, we will break down the specifics of this trading strategy, and with a little personal tweaking, it could become a valuable part of your overall trading approach.
First let’s break down the idea behind this FX strategy a bit. The Range Expansion Reversal Strategy is essentially a reversion to mean strategy. Reversion to mean is a statistical term that refers to the following mathematical law: over time, data will tend to return to the mean, or average, of the entire data set. Therefore, in this strategy that means that as a currency pair exhausts its daily range each day, it tends to reverse at some point and return back into the average daily range; thus, this strategy is called range expansion reversal strategy-as a currency pair exhausts its average daily range, we are looking to fade the daily momentum in anticipation that the currency pair will return back into its daily range.

1.AVERAGE DAILY RANGE

Currency pairs do not move an infinite amount of pips per day. In fact, under normal market conditions, a currency pair generally moves within a relatively predictable range known as the Average Daily Range. Average Daily Range is calculated as follows:
(1)DETERMINE THE DAILY RANGE OF A CURRENCY PAIR OVER X NUMBER OF DAYS
This can be done be done manually, but the best is to use an ADR indicator. Your forex platform should have that available. You should be able to see the ADR over any number of days you choose. It is best to look at the ADR over the last 5, 10, and 20 days. If the numbers are all similar, say 120 pips plus or minus a few pips, then that gives you a good idea that the currency pair is generally moving about 120 pips in current market conditions. Now that you understand how to find the average daily range, let’s break down how to use this information to formulate an actual trading approach for the forex market.
Once you determine the average daily range for a currency pair, then you simply look from the day’s open at midnight and determine where that price area is on the chart. For example, let’s use the EUR/USD and assume that the EUR/USD opens the day at 12:00 am est at a price of 1.2200. You want to let price make its move between 12:00 am and 5:00 am. During this time, the market will begin to form the HI and LO of the day. Take a look at this chart:
You can see the day opened at midnight est at 1.2880. Then as London opened up, price fell to a low of 1.2788 before price moved back up to 1.2811 just prior to the NY Open. Now, during the NY session, you know where price may find support if it keeps moving to the downside or resistance if it moves strongly to the upside. Assuming the ADR is 120 pips, then the euro should find support somewhere around the 1.2760 area. This number is calculated by taking the HI of the day (1.2880) and subtracting 120 pips (ADR). Conversely, if the low at 1.2788 holds and the euro finds lots of buying strength during the NY session and pushes higher, then it should find resistance in the 1.2910 area. This number is calculated by taking the LO of the day (1.2788) and adding 120 pips (ADR). You now have a general idea of where price is going to find either support or resistance during the NY trading session.
(2)THE NEXT STEP
Once you pinpoint these potential areas of support and resistance, you want to back out to the higher timeframes (1 Hour and 4 Hour) to see if there is any substantial support/resistance in these price areas that may offer further support for your trading idea. Any number of technical tools can be used, but horizontal support/resistance, Fibonacci retracements/extensions, and pivot points are a few of the best.

The chart above is a 4 Hour Chart. You can see that the resistance level of 1.2910 has quite a bit of resistance. First of all it is the previous swing HI on the 4 Hour Chart, and to the left you can see that this area has acted as strong support for several days. The green shaded boxes show several failed attempts for price to move above this price area.
To the downside you can see that the 1.2760 area we calculated is the 50% fib of the last swing on the 4 Hour Chart, which is quite significant. Also, you can see the green shaded box on the 50% fib level where this 1.2760 area was a strong level of resistance. Now that price has broken through this level, it should act as support if the euro does continue to move down during the NY trading session. You can also see further to the left in the green shaded box that the 1.2760 area has acted as support for price before.
Now, you have a trading plan. You have confirmed support in the 1.2760 area and you have confirmed resistance in the 1.2910 area. As price begins to move to one of these two areas during the NY trading session you are going to be poised and ready to engage the market and fade the daily momentum back into the currency pair’s average daily range.

2.WHAT TO LOOK FOR AND WHAT TO AVOID WITH THIS STRATEGY

Let’s start by reviewing the following chart of pricing behavior for the “EUR/USD” pair:
From our earlier discussion and literature on the web, the Range Expansion Reversal Strategy is essentially a reversion to the mean strategy. Reversion to the mean is a statistical term that refers to the following mathematical law: over time, data will tend to return to the mean, or average, of the entire data set.
Therefore, in this strategy that means that as a currency pair exhausts its daily range each day or is in the midst of expanding it, it tends to reverse at some point and return back to achieving the average daily range. The reversal point is often a strong support or resistance level established recently, typically determined visually or with the aid of Fibonacci tools. The goal then becomes fading the daily momentum in anticipation that the currency pair will return back into its daily range or expand to fill it.
There are three situations depicted in the above diagram. The first situation is a high-percentage set-up, while the next two are exceptions to the rule that should be avoided to improve your performance with this strategy. Let’s review the characteristics of each situation.
Paul Tudor Jones, a very famous trader that amassed a billion dollar fortune from his trading prowess, once remarked, “When you see a range expansion, the market is sending a very loud, clear signal that it is getting ready to move in the direction of that expansion.” In “Situation 1”, the Euro began a strengthening move during the Asian session, then reversed off support established the previous day, just prior to the London open. The ATR indicator began ascending at that point, a range expansion signal that Jones would have surely noticed.
The London session added 55 pips, far short of its daily average of 120, setting the stage for the impending New York opening. The odds favoring a trade set-up are always increased when you have more evidence to support your interpretation. Here we have a reversal off support, range expansion, and ample room left in the average daily range to absorb. The trend wave is set to move upward, offering a good opportunity for gain.
This reversal strategy does not always work, as can be seen in the next two examples. In “Situation 2”, the Euro continued its upward run, but reversed severely during London trading, overrunning its daily average by a full 60 pips. New York trading was flat. Would there be a bounce back in “Situation 3”? Not in this case. Think of in terms of an athlete that has expended maximum effort, but has nothing left in his energy tanks to do a quick repeat performance. When a Max and Min of the ATR come so close together, it is an indication that volatility has run its course. The market needs time to recover.

3.ENTRY POINTS AND RISK MITIGATION

This strategy favors a quick-in, quick-out mentality. Since we are dealing within a pre-defined range of circumstances, namely the average true range and how much room is left for potential momentum gains, our profit expectations must be modified accordingly. Before jumping into a position, it is also helpful to know where key support and resistance levels reside. Applying the average daily range to the high or low for the London session is one factor. It is also recommended to review past trading history for similar price levels and to apply Fibonacci lines to previous strong market movements.
In order to finalize our execution instructions for “Situation 1”, let’s take a closer look at it under a 15-Minute microscope, as depicted in the following chart:
The focus again is to take advantage of what might transpire during New York trading. In this example, momentum started in London, and all signs suggested that it would continue when New York opened. The best entry point in this case is to wait for the usual profit taking on a positive run, which typically occurs before New York opens, to run its course. A Stop-Loss order of 25 to 30 pips is recommended (25 is taken here), with a “2X1” reward/risk ratio applied to establish a prudent Take-Profit position. In this case, that figure fell just below the projected ceiling for the average daily range.
It is not prudent to get too greedy with this strategy. Patience is often the order of the day, since it may take time to develop on a short timeframe window, but trust your instincts and disciplined approach to the market. Part of the reason this strategy works is that other traders and automated trading robots are wise to these predictable moves. You can assume that much of the trading community is already savvy to the above expectations before you are. For this reason, it is advisable to get in and get out quickly. Be happy with a 50-pip gain. The more often the better, and this set-up occurs more frequently than you might imagine. Be patient, but be prepared to act quickly.

4.RECAP OF THE RANGE EXPANSION REVERSAL STRATEGY

The Range Expansion Reversal Strategy can yield many profitable trading set-ups, as long as you apply these principles carefully and heed the exceptions to the rule – avoid the set-up if the average daily range has been exceeded during the London session and avoid situations where volatility has hit high and low levels in a very short period of time. The simple fact is that strategies based on averages work best under normal situations, but when chaos prevails, most formulaic approaches go out the window.
Only very experienced traders are adept at making gains during chaotic trading sessions. It is often best to wait until the dust settles before venturing back into the choppy waters of forex. Your objective is consistency, based on a step-by-step trading plan that adapts to changing situations in the marketplace. You make your own luck, so to speak. Those gambling traders that depend on luck soon become market casualties.

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  • 看似比較偏門的策略,我最近去實踐一下,看看效果如何

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  • 不管用不用文中的策略交易,知道一个交易类别的日均波幅有多大,对设置止盈止损也非常有用。

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  • This is a new way for me to trade, and it feels great.

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  • Once you have determined the average daily range of the trading category, you only need to look at the opening price at midnight that day and determine the position of the price area on the chart. This is very important!

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  • Before entering a certain position, it is also helpful to know where the key support and resistance levels are.

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  • This strategy is very practical, and I only started contacting it last year.

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