Variations On Range Expansion

To establish a trend you can read about the myriad of indicators, signs and signals that could let you know if it exists or not. Mark Boucher’s 10 week lesson has a great section on trend qualifiers, as does Dave Landry’s work all over. Ultimately, I use MACD or ADX programmatically to establish a trend.

To establish an overbought or oversold condition, again there are many mechanisms you could use. Programmatically I am using a 5 period fast stochastic with 44 and 56 as the signal lines. Really I am just looking to see that a market is NOT overbought if I am selling and NOT oversold if I am buying.

The main point of this article; to establishing range contraction we will use an ATR Ratio; a short term ATR divided by a longer term ATR. Effectively what we are saying is; the market’s true range is typically X and presently it is Y. If the short term ATR is much smaller than the longer term ATR then we can see that the current market is contracted. This gives us insight as to weather or not range will be generally set to expand again. For this example I am using a 4 period ATR / a 30 period ATR and a .7 signal line. You can adjust these as you will, however my testing has shown these values to be pretty effective.

Unlike most range contraction strategies, I am not looking to go long or short based on the directional expansion. I am looking to follow the larger trend out of it’s overbought/ oversold condition. As is common for range expansion techniques I use an ATR multiple to enter this setup. I prefer to exit off of the prior close, however you could apply whatever actual entry signal you like, I am merely trying to display how the added layer of range contraction could benefit a system. My exact entry technique buys or sells when price the price moves .7 * the 8 day ATR. What this is saying effectively is; if the price moves more than ½ of your 8 day average range in the direction of the major trend out of a contraction, then we are expanding and reasserting so enter a trade.

These 3 fairly recent examples, 2 from the QQQ, 1 from the BBH show signals generated by this method. Adding this layer of range contraction to your system will surely generate fewer signals than without it, however it will also allow you to be in the market for a short time period and out when you can be.

Other variations on this method include using just a ratio of a short term range to a long term range (not ATR but plain range). I do prefer the ATR signal as Average True range takes into consideration overnight gaps and the like to establish a more accurate idea of range. I have, however, found similar results with the range signal. I often will accept either an ATR Ratio signal or a Range Ratio signal, as they generate similar but not always exactly the same signals so accepting either or will give you a few more entry signals.







The main thing I like about this method is that it makes sense to me. Usually the range is bigger than it has been lately. I bet it will go back to how it usually is soon. Let’s capitalize now.

Good Luck and feel free to email me for any tradestation code for these indicators at chrisdonnan@hotmail.com.

My best,

Chris
 

Chris Donnan lives in Brooklyn, New York. He is a professional software engineer and an avid trader.