The other day I got the following email about narrow range bars:
I was going through your site and others and I keep on hearing, no entry on narrow range bars. What is a narrow range bar, and could you send me a picture of one?
A narrow range bar (candle) is simply a bar which has a range from high to low that’s much less than the average bar for a given equity. You’ll often see people, like Dr. Sen, tracking NR7 bars. NR7 means the narrowest range of the last seven bars. For example, here are some NR7s from last Friday:
So now that you know what narrow range candles are, why should you care about them? Since stocks generally cycle between periods of low volatility and high volatility it can be beneficial to identify when the high volatility times are approaching. Often times, especially for trending charts, narrow range periods — periods of range contraction — will presage range expansion. You can think of a stocks movement like a spring / slinky — it need to recoil (contract) in order to build up enough potential energy for its next expansion. However, it’s important thing to note that range contraction doesn’t tell you the direction of the impending expansion only that an expansion may be coming. It’s up to the trader to use other means (indicators, common sense?) to catch the expansion in the right direction.
One of the nice things about trading against narrow range bars is that they give you a tight stop. If you size your positions like I do, the smaller the stop means you can buy (or short) more shares. It’s the trades with the really tight stops that let you make those huge R-Multiple trades that often make or break a trader. Here’s an example from a trade I took last week.
I’m going to use the actual entries taken by myself and by Butterboy but instead of using my actual exits, I’ll assume I held until the close. So let’s say my equity is $100,000 and my R, the amount I want to risk per trade, is 1% or $1,000. Given that, here’s the first trade, based off of my actual entry parameters:
- Entry at 53.96
- Stop was 50 cents higher so I could short 1000/.50 or 2,000 shares
- DGX closed at 49.64, which is $4.32 lower. So that trade returned $8,640 or 8.64 times my risk (8.64R)
Here’s the DGX trade using Butterboy’s entry criteria. He used a 15 minute chart and entered lower than I did but his stop was also much tighter:
- Entry at 53.40
- I believe his stop was 21 cents higher, just above the 11:30 bar which he entered against. Given that one could short 1,000/.21 or just over 4,700 shares.
- DGX closed at $3.76 beneath the entry so that trade returned $17,672 or 17.67 times the initial risk (17.64R).
It should be clear why so many of us like narrow range bars and why I scan for them. That second trade had a worse (lower) entry but because of its tighter stop it was almost twice as profitable. It also shows why I love the percent risk position sizing model.
Here’s an article on range contraction written by Oswald S. Castillo, TheStockStalker and very possibly the #1 fan of range contraction trading. Oswald also has a webinar on his site entitled “Principles of Trading Range Contraction”. It’s a good video but you have to register to view it.
P.S. I almost forgot to answer the question of: How Narrow is Narrow?
For daytrading I like to find candles that are 1% or less than the price of the stock. So for a $20 stock any candles with a range of 20 cents or less really get my attention. In cases like those I just need small moves in the stock to rack up some nice gains. I’ll typically pass on candles with a range much greater than 1% because they’ll require a much larger move in the stock in order for me to get those large R-multiples.
For swing trading (looking at daily charts) I don’t have a concrete answer on how narrow is narrow. But you could probably come up with some value based on the stock’s average true range (ATR) or some other method. For example, you could define narrow as less than half a stocks ATR.
NRx (narrowest range on the last X candles) is always a good way to go as well, and it’s easy to scan for.