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Advanced Range Bar Size Selection
Selecting the correct range bar size is a critical skill for any trader who wants to use this powerful charting tool effectively. A well-chosen range bar size can filter out market noise, reveal the underlying trend, and provide clear entry and exit signals. A poorly chosen size, on the other hand, can lead to confusion, missed opportunities, and unnecessary losses. In this lesson, we will explore advanced techniques for selecting the optimal range bar size for your trading style and the specific market you are trading.
The Problem with Fixed Range Bar Sizes
Many traders make the mistake of using a fixed range bar size for all market conditions. For example, a trader might use a 4-tick range bar for the E-mini S&P 500 (ES) futures contract, regardless of whether the market is in a quiet, low-volatility session or a fast-moving, high-volatility session. This approach is suboptimal because it fails to adapt to changing market dynamics. During periods of low volatility, a 4-tick range bar may generate too many bars, creating a noisy and difficult-to-read chart. Conversely, during periods of high volatility, a 4-tick range bar may generate too few bars, causing you to miss important price swings and trading opportunities.
Dynamic Range Bar Sizing with ATR
A more effective approach is to use a dynamic range bar sizing method that adjusts to changes in market volatility. One of the most popular and effective ways to do this is to use the Average True Range (ATR) indicator. The ATR is a measure of market volatility that was developed by J. Welles Wilder Jr. in his 1978 book, "New Concepts in Technical Trading Systems." The ATR is calculated as the greatest of the following:
- The current high less the current low
- The absolute value of the current high less the previous close
- The absolute value of the current low less the previous close
The ATR is typically calculated on a 14-period basis, but you can adjust this setting to suit your trading style. A shorter ATR period will make the indicator more sensitive to recent price changes, while a longer period will make it less sensitive.
To use the ATR to determine your range bar size, you can simply set your range bar size to a multiple of the ATR. For example, you might set your range bar size to 25% of the 14-period ATR. This means that if the 14-period ATR is currently 10 ticks, your range bar size would be 2.5 ticks. If the ATR increases to 20 ticks, your range bar size would increase to 5 ticks. This dynamic approach ensures that your range bar size is always appropriate for the current market conditions.
Worked Trade Example
Let's say you are trading the E-mini S&P 500 (ES) futures contract and you are using a range bar size that is equal to 25% of the 14-period ATR. The current 14-period ATR is 12 ticks, so your range bar size is 3 ticks. The market is in an uptrend, and you see a pullback to a key support level. You decide to enter a long position at 4,500.00. You place your stop loss at 4,497.00, which is just below the support level. Your profit target is 4,509.00, which is a key resistance level. Your position size is 1 contract. Your risk on the trade is 3 points, or $150 (3 points x $50 per point). Your potential reward is 9 points, or $450 (9 points x $50 per point). Your risk-to-reward ratio is 1:3.
The market rallies and your profit target is hit. You exit the trade for a profit of $450. This is a good example of how using a dynamic range bar sizing method can help you to identify high-probability trading opportunities and manage your risk effectively.
When Range Bars Fail
It is important to remember that range bars are not a holy grail. There are times when they will fail to provide clear signals. For example, during periods of extremely low volatility, range bars can become very choppy and difficult to read. In these situations, it may be better to switch to a time-based chart, such as a 5-minute or 15-minute chart. Additionally, range bars can be susceptible to "whipsaws," which are false breakouts that can lead to losses. To avoid whipsaws, it is important to use other technical indicators, such as volume and momentum, to confirm your trading signals.
Institutional Context
Proprietary trading firms and hedge funds often use sophisticated algorithms to trade the markets. These algorithms are often based on range bars and other non-time-based charting methods. The reason for this is that range bars can help to filter out market noise and reveal the underlying trend, which is exactly what these algorithms are designed to do. By using range bars, these institutions can gain an edge over other market participants who are still using traditional time-based charts.
Key Takeaways
- Avoid using a fixed range bar size for all market conditions.
- Use a dynamic range bar sizing method, such as the ATR, to adjust to changes in market volatility.
- Always use a stop loss to manage your risk.
- Be aware of the limitations of range bars and use other technical indicators to confirm your trading signals.
- Understand that institutional traders often use range bars to gain an edge in the markets.
