Market goes through a regular contraction (i.e. daily trading range getting shorter and shorter) and expansion (i.e. daily trading range getting bigger) cycle. The trade setup is to wait patiently for market to enter in contraction i.e for range of the bars to reduce, once you spot NR4 or NR7, you will bet that bigger price movement will follow and you get direction and start of it once it breaks either the high or low of the range formed by NR4 or NR7 bar.
Narrow Range trading strategy or NR7 Trading strategy is a breakout based method which assumes that the price of security trends up or down after a brief consolidation in a narrow range. The default lookback period of this strategy is 7 days which means that if the price range of any particular days is lowest as compared to last 7 days, then that day is termed as NR7 day.
Similarly, if the price range of any particular days is lowest as compared to last 4 days, then that day is termed as NR4 day. Here the range is calculated as the difference between High and Low of the particular day. The day following NR7 day acts as a confirming factor on where the price will move further. Breakout of the High of NR7 candle with high volumes indicates bullishness, while breakout of Low of NR7 candle indicates bearishness. The philosophy behind the pattern is similar to the Bollinger Band Squeeze: a volatility contraction is often followed by a volatility expansion. Narrow range days mark price contractions that often precede price expansions. See the below chart for a visual explanation:
NR4 and NR7 are simple methods that try scan for stocks that have been seeing squeezing volatility, in a narrow range (High to Low of some previous time-period). Traders remain alert about any price movement breaking-out of this range. They trade in the direction of the break-out.
How to Find NR7 day?
1) Get the High and Low data of last few periods
2) Calculate the range of each day i.e. high – low) for each day
3) Compare the range of a today and previous 6 days range (to get NR7. To get NR4 get last 3 days range)
4) If today’s range is smallest of all 7 days, then today is NR7 day..else not.It is that simple.
It gives u a chance to be ahead of trade follower/indicator followers who will jump in the trend after you. One of the easiest ways to trade this setup will be to go long above the Day’s high of NR7 day with a stop at the Day’s Low of NR7 day.Or Go short below the Day’s Low of NR7 day with a stop at the Day’s High of NR7 day.
Observing this pattern gives day trader /swing trader a distinct edge to trade next 1 or 2 days. In many cases, NR7 break-out is found near the start of a new wave. For a day trader, this setup indicates that they can anticipate wide range days, so they should be prepared to chase the trend and use trailing stops so that they can get maximum from the coming trend.