What it means
On a chart, a sideways market looks like a horizontal channel. The top of the range is called resistance, where sellers tend to appear, and the bottom is called support, where buyers tend to appear.
Investopedia says trading volume usually stays flat while bulls and bears are balanced, and spikes when a breakout or breakdown is expected. Sideways periods often come before a new trend.
They can be a pause inside a longer rise or fall, which is why technical analysts also call them consolidation. A sideways market is shorter and tighter than a secular sideways phase, which can last for years.
Traders can try to profit in two ways. One is range trading, in which a trader buys near support and sells near resistance with a stop-loss order just outside the range.
Investopedia suggests the range should be wide enough for a 2:1 reward-to-risk ratio. The other is selling options, because option premiums lose value as expiration nears if the price stays inside the range.
The options route has a sharp downside. FINRA explains that the seller or writer of an option accepts an obligation if the buyer exercises.
A short straddle, which sells a call and a put at the same strike, earns limited premium but can lose a lot if the price breaks out. For long-term investors, a sideways market means little capital growth.
Dividends or interest may provide most of the return, and a broad mix of assets helps. Frequent trading adds commissions and takes time, so profits can shrink to nothing.
In practice
Real-world examples.
Example
A fictional stock bounces between support at $95 and resistance at $105 for several months. A trader buys 100 shares at $96 and plans to sell at $104, a gain of $8 per share, or $800. After $30 in commissions for both orders, the net is $770.
Example
The same trader sets a stop-loss at $94. If the price breaks down, the loss is $2 per share, or $200, plus $30 in commissions, which is $230. The potential gain of $8 is four times the risk of $2, which clears the 2:1 guideline.
Example
A fictional options trader sells a straddle at a strike of $100 and collects $11 per share (a call at $6 and a put at $5). If the stock ends at $100, she keeps all $11, but if it ends at $120, she loses $20 on the call and keeps $11, a net loss of $9. The breakeven points are $89 and $111.
Formula
Calculation
Range = Resistance - Support. With the fictional stock, $105 - $95 = $10, which is 10% of the $100 midpoint.
Reward-to-risk ratio = (Target - Entry) / (Entry - Stop). With ($104 - $96) / ($96 - $94) = $8 / $2 = 4.
Short straddle breakevens = Strike +/- total premium. With $100 +/- $11, the points are $89 and $111.
Costs matter in a tight range. On 100 shares, a winning trade makes $8 x 100 = $800 and a stopped-out trade loses $2 x 100 = $200. With $30 of commissions on each round trip, the net gain is $800 - $30 = $770 and the net loss is $200 + $30 = $230. The trader needs a win rate of $230 / ($230 + $770) = 23% just to break even, and a higher rate to earn a return worth the time.Case study
Seen in the real world.
This case study is fictional and illustrative. Tomas, 44, in Prague, notices that his index fund has moved between $95 and $105 for eleven months. A forum tells him to trade the range and sell options for income. He tries range trading with a small account. In month one he makes six round trips of 100 shares, each with a net gain of $770.
That adds up to $4,620 before taxes. The next month the price slips below support and his stop-loss order sells at a loss. Commissions of $30 per round trip also add up. Tomas then looks at his time. He spent hours each week watching charts and still earned less than he expected after losses and taxes.
In the month the price broke below support, two stopped-out trades cost him 2 x $230 = $460, which cancelled out more than half of the $770 earned on a single winning round trip. He moves most of his money back to a regular monthly plan and keeps a small amount for trading practice. He learns that a sideways market rewards strict rules and low costs, and that a breakout can erase many small gains.
Watch out
Common mistakes.
- Assuming the range will hold forever when a breakout in either direction can start at any time.
- Ignoring commissions, which can swallow the small gains of range trading.
- Selling options for steady premium without understanding that the loss can be much larger than the premium.
Questions
People also ask.
What is a sideways market?
It is a period when price moves within a tight range without a clear up or down trend, because buying and selling are balanced.
What comes after a sideways market?
Often a new trend, up or down, though the direction cannot be known in advance. Volume often rises at the breakout.
How do traders profit in a sideways market?
Some buy near support and sell near resistance. Others sell options and earn premium, which carries the risk of large losses if the price breaks out.
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