The terms “trading range” and “breakout” are often used when referring to the investment markets. In fact, the major indexes are currently in a trading range. For the S&P 500, the range is approximately 1,100 to 1,225 and for the Dow Jones Industrial 30 it is 10,800 to 11,600. Ranges typically occur when there is insufficient data to cause a breakout; for the index to continue through either the top or the bottom of the range.
During 2011, the markets trended in a positive direction for the first half of the year and then the correction began around the middle of July. By Aug. 8, the S&P 500 closed at 1,119, near the bottom of the current range. Since that date, the index has closed near the bottom of the range on five occasions. In between each of these dates where the index was near the bottom, the index traded up toward the top of the range.
The trading range can provide investment opportunities for many investors and often frustration for everyone else. The 125 point current range of the S&P 500 represents an eleven percent move in the markets. While the market may not move from the absolute bottom to the absolute top of the range during each short term trend, the moves are often sufficient for many investors to make short term profits; they buy into the markets when the market nears the bottom of the range. When investors buy in near the bottom of the range this is generally referred to as “support” for the markets. Without new data becoming available indicating the economy is weakening, the market will continue to find support each time the indexes trade near the bottom of the range.
The influx of buying in the markets will generally reverse the index’s direction and thus start trending to the top end of the range. Again, absent of new data indicating there are reasons for the markets to continue higher, many ‘traders’ start selling near the top of the range thus creating a temporary ceiling to the indexes. This trend can be repeated numerous times before new data becomes available which may cause the markets to break out of the range. Depending upon the weakness or strength of the data, will be the determining factor of whether the markets breakout to the top or bottom of the range. Both the floor and the ceiling of these ranges are not absolute and often the smallest piece of information or concern can cause the markets to break through. Thus, while 1,100 may be the current range floor, investors should recognize it could change in a moment’s notice.
For most investors, trading ranges may create more frustration than opportunity. In my opinion, buying and selling mutual funds because of trading ranges is not the best option. The managers of most funds will be taking advantage of the trading range through reallocation of the individual securities held inside the fund.
For long term investors who own individual securities it may be advantageous to add to positions within the account that have sold off due to the markets trading near the bottom of the range. As the indexes trend back to the top end of the range, those positions within the account that have also recovered but now make up too much of the account, can be sold off or reduced back to an acceptable percent of the portfolio. To utilize this strategy requires active management of portfolios and perhaps more work than many investors care to invest.
Trading ranges are one of those times when investors must remain patient so they don’t miss the opportunity when the break out to the upside occurs.
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