Get Ready for Narrow Ranges

Here are some tips on trading for those tricky days ahead.
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This column was originally published on RealMoney on Nov. 17 at 1:22 p.m. EST. It's being republished as a bonus for TheStreet.com readers.

At this point, the big question on every investor's mind is probably when this market will finally top? When is the right time to start cashing in on some profits?

For traders, though, who focus more on the day-to-day action, the question is likely how their trading will be affected once the market does top off.

Holiday Trading

Obviously, at some point, we will get a more significant top, and things will level off for a while. If you look back at the

Nasdaq Composite

over the past few years, you can see that kind of leveling-off has often happened right around the holidays.

In 2004, we had a pretty steady uptrend starting in August, and then around Thanksgiving through the beginning of December, the market leveled off.

In 2005, we saw a steady uptrend from the beginning of October until right around Thanksgiving, and then a leveling-off. So as we approach the holiday season, be aware that intraday patterns might be changing, and you'll need to adjust your trading accordingly.

Long-Term View
Here's a three-year look at the Nasdaq

In certain situations, I anticipate narrower and choppier trading ranges. One of those situations is the day after an unusually wide-ranging day. Take a look at the

Nasdaq 100 Trust

(QQQQ)

over the past few months as an example.

On June 26, it had a $1.26 range for the day. On Sept. 12, it had an 85-cent range for the day. On Oct. 4, it had a $1.17 range. On Nov. 1, the range was 95 cents. Those were among the widest ranges in the past five months.

Now look at the following days after those wide-ranging days. They all had something in common. All of them continued in the same direction as the previous, wide-ranging day, and all of them were relatively narrow days. Roughly speaking, on an average day the QQQQ might range around 50 to 60 cents, and on a narrow day, more like 30 cents. So whenever I see the QQQQ ranging closer to a dollar, I expect a narrow range the following day.

Watching the Q's
Here's a six-month chart

Other situations in which I anticipate narrower and choppier trading ranges include summertime and the week leading up to any holiday. When volume is lower, things can get really volatile, and we sometimes see news-driven stocks go crazy. But anything with large institutional interest is usually neglected around that time, so ranges get narrow and the market can become unbearably slow.

What to Expect

When the market is topping off, we also get into some choppy action and narrow ranges. Think about the psychology of a market top. We're dealing with a lot of uncertainty, greed and regret. All of that emotion can lead to a lot of false alarms, whip-backs and spikes. But it can also lead to a lot of wait-and-see action, a.k.a. narrow ranges.

Take a look at last week's action. Normally, stocks swing up and down throughout the day, along their way to wherever they're trending. But last week,we ran into a pattern of spiking and then going flat.

Let's take the QQQQ again as an example. On Nov. 6, it made an early spike from $42.06 to $42.58 in the first half-hour of trading, and then drifted in a 20-cent range for the rest of the day. On Nov. 7, it did almost the same thing, with an early spike from $42.53 to $43.09 in the first hour, then it slowly drifted sideways. On Nov. 8 and 9, the morning ranges were narrow and drifty, until larger spikes or drops came in around 1 p.m ET. This is very tough action to play. If you miss that one big move, your day is a bust.

So how does one deal with this type of action? If I expect a narrow range, how does that alter my behavior?

Stick With Your Plan

It helps somewhat just to be aware that the day might be narrow. In retrospect, of course, it's easy to pinpoint. But when you're in the thick of things and the ranges are just beginning to develop, you can't easily tell if it's going to be a narrow day. The hard part is making decisions based on the information you have at the time.

A big part of trading is forcing yourself to be disciplined and stick to a routine, a plan, a set of criteria. That's easy to do when trades are flowing and there's a lot of predictable movement in the market. That kind of environment is conducive to being selective, only taking high-quality setups, keeping all your stops tight and jumping back in when you feel optimistic because the market is handing you one great opportunity after another. If the market is cooperative, you can readily get into a groove and believe you're one of the greatest traders alive.

On the other hand, when there's a drought, it's a lot harder to be disciplined. It's hard to be selective when you have that sickening feeling that you need to find at least one good trade just to pay your mortgage, and it's slim pickins out there. It's hard to be disciplined when you're bored and want some kind of trade -- any trade. But as I said, much about trading is forcing yourself to stick to a plan and be disciplined.

So when you suspect a narrow day, first be aware that it might be harder to find trades that meet your criteria. Next, resolve that you will not compromise because you know that will leave you with inconsistent results. Make sure you have a list of your trading criteria visible in front of you. Go down the checklist for every trade if you need to, and ask yourself if it really meets your criteria. And realize that you might go an entire day without seeing a single good trade.

Another way to prepare for narrow days is to factor them into your goals. You can't set a daily goal based on the gains you make on good days. You have to set your goals based on averages over time. It's like fishing: One day you might catch five, so eat one and put four in the freezer because you might not catch any more for the rest of the week. So don't set your goal at five trades per day; set it at 20 per month. That sounds obvious, but you'd be surprised how greed can sometimes cloud your logic.

So make yourself a little mental "savings account." If you make some "extra" gains one day, instead of dreaming about what you are going to spend it on, tuck it away for a rainy -- or narrow -- day.

At the time of publication, Wolff had no positions in any of the stocks mentioned, although positions may change at any time.

Ken Wolff is founder of MTrader.com, the first educational daytrading site on the Net, and co-founder of InvestingOnMomentum.com, a Web site devoted to short-term potential for retirement accounts. TheStreet.com has no affiliation with InvestingOnMomentum.com, and no endorsement of InvestingOnMomentum.com or momentum trading is intended. While Wolff cannot provide investment advice or recommendations here, he appreciates your feedback;

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