Over the past year the ASX 200 has traded in an extremely tight range, conditions that could be problematic for many traders who prefer to open positions when the market gives a clear signal as to whether it's headed in an upward or downward trend.

Nevertheless, there are ways to trade markets when they are not giving participants much to trade on. But it takes skill and knowledge to use these techniques.

To demonstrate how tight markets are, between November 9, 2015 and November 9, 2016 the ASX 200 moved only 57 points, from 5099 to 5156 points. 

Chris Weston, chief market strategist with IG, says these conditions are great for investors but not so great for traders.

"When we see violent moves in markets, traders are expressing wide-ranging views on an event or theme. When markets have big moves, positioning tends to become exaggerated and this creates huge opportunity. Trading is about finding misalignments in price," he says.

Weston says range-bound markets can be successfully traded, and he has clients who seek out markets that display these behaviours. He says one of the best ways to range trade markets is through combining the use of Bollinger Bands with a relative strength index.

How they work

Bollinger Bands are a measure of volatility that effectively bracket the 20-day moving average of the price of a security. When the average moves towards the edge of the lower band it suggests the price of the security is cheap. If the price heads towards the top of the upper band it indicates the market is expensive.

The relative strength index measures the strength or weakness of a security according to recent closing prices.

"When the 20-day moving average is headed perfectly sideways and the RSI is mid-range, this confirms traders should look at range-trading strategies. When we get that confirmation of a sideways or range-bound market, wait until the price moves to the top band. If it marries with the RSI hitting 70, then traders would short the asset and look for reversion to the mean, the 20-day moving average, and buy the asset when the price hits the lower Bollinger Band, married with the RSI hitting 30," Weston says.

Gary Burton, a research analyst with IG, says that one of the true tenets of the sharemarket is that times of low volatility lead to high volatility and high volatility leads to low volatility.

"Quiet times in the market offer the trader an opportunity to do further stock and sector-specific analysis without all of the noise of moving prices. By reflecting back on the price charts, traders can see what happened in the past as a potential indication of future movements," he says.

Burton adds that when markets move in small ranges, stop buy and stop sell orders can be placed to capture any movement when the price starts to shift. "There is no cost to having a limit order in place. These orders are placed above for the stop buy and below the current trading range for the stop sell. Often movements from the consolidation periods can be volatile, so stop loss orders should be in place with take profit orders."

When to research

This type of order placement allows the trader to enter a range-bound market when it does have support, and sell out at resistance levels.

"The first task is to establish the range of the market by identifying the support and resistance levels. A limit buy order is placed at support levels. When resistance is reached a limit sell order can be placed to open the short position," Burton says.

He says if traders are unfamiliar with this strategy, then quiet times provide an excellent space to research this type of order and its ramifications.  

Chief executive officer of Saxo Capital Markets Australia, Ben Smoker, agrees that traders inherently rely on the market moving to make a profit.

"When markets move in tight ranges, the opportunity to take advantage of sharp movements to either the upside or downside are reduced, and so opportunities to make money from short-term volatility is lessened," says Smoker.

"Additionally, in low volatility markets, the length of time a trading position may be required to be held by a trader to reach a target level for profit-taking is often extended. This incurs an additional headwind for the short-term trader and is known as the phenomenon of cost of carry."

That is, cash allocated to holding trading positions incur either financing costs over the duration of the trade or an opportunity cost that could have been deployed elsewhere, such as in an interest-bearing security or a term deposit. Smoker notes the low interest rate environment has increased traders' appetite to hold positions for longer.

Ways to take advantage

He says there are three ways traders can take advantage of range-bound markets. 

The first is to write straddles or strangles over stocks, futures or currencies. This allows investors to take advantage of a market that is not moving by collecting premium from worthless options that are expiring.

In both straddles and strangles, traders sell the same number of put and call options over a security that expire on the same date. Straddles have the same strike price, allowing traders to profit no matter what direction the price of the security moves. Traders use a strangle if they have conviction the price of the security will move in a certain direction, and two different strike prices are used.

The second strategy is a covered call/buy-write strategy, where a trader writes an at-the-money or slightly out-of-the-money call option over an existing holding and seeks to collect the premium of the short call as the option expires worthless as a result of minimal movement in the underlying security up until expiry.

The final strategy involves writing a one-touch currency option. A trader sells a one-touch option under the expectation that the strike price will never be "touched" by the underlying security. This allows the trader to collect the premium of the short option position, relying on little movement in underlying price.

All these strategies are sophisticated and require confidence when trading. It is worth trading on a demo account to try these techniques out before risking real money on them.