Trading against the trend: User instructions
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Trading against the trend means taking positions in the opposite direction to an asset’s trend. Most often, traders simply capture correction movements, a retracement of the trend movement. In rarer cases, traders benefit from a trend reversal and therefore capture a lot of the movement. With trading against the trend, it is quite possible to earn as much as a trend trader. The important thing is to have a strategy that is consistent with your psychology.
The reasons that motivate traders to trade against the trend are multiple and are far from being the right ones in most cases:
- Proving they are better than other traders: We're not going to deny it, it's so nice to say "I told you so." And show other traders that we've been smarter or more observant. The feeling of being the only one right is rewarding. It is this excitement that a lot of traders look for when trading against the trend.
Very often, these traders have a longer term vision of their trading. Being right when everyone is wrong in the short term is good but not many people know. If you are right in the long run, the "I told you so" is even more enjoyable. Go on admit it... it's great! And then, if that happens, it only takes one big trade to make a name for yourself in the business (see Mr Belkhayate with gold).
- Feeling the market is oversold/overbought: This is a classic, especially among novice traders. It's gone down or up a lot, it's bound to turn around It's underestimating the strength of the trend, etc. If an asset's price collapses (or soars), there is a reason. A lot of traders raze their trading account by persisting in wanting to be right against the market. Trade against the trend if you wish, but it shouldn't be on a hunch!
- Believing they can earn more: Many traders who trade against the trend say that they take the trend reversal movement right from the start to get higher profits. The problem is that in most cases, the trend does not reverse. You're just going to take a correction movement. If you think that trading against the trend is a way to make a fortune, you're wrong!
- Having a contrary nature: Some traders question every movement. It's going up, why did it go up? Is that justified? It's a good thing to have this approach, but it shouldn't become an obsession either, otherwise you will start a trend of “it's gone up, I’ll sell”. The majority of traders who trade against the trend open a position on a subjective sentiment when, on the contrary, they should be as objective as possible!
To trade against the trend, you first need to identify the asset’s trend. This is not done on your signal chart (time unit of your trade) but on your trend chart (upper time unit chart). These are the rules of one-way trading. If the trend is bearish on your trend chart, then you will only take into account the bullish signals on your signal chart. Conversely, if the trend is bullish, you will only consider the bearish signals on the signal chart.
An against the trend position should only be opened when there are clear signals. Your reasons for opening a position should be objective and not subjective! The signal can come from an indicator or the price chart.
In both cases, you first need a signal on the trend chart, then look for a buy/sell opportunity on your signal chart. You can use the same detection tools on both your trend and signal charts.
A signal on an indicator (I advise you to use the RSI or the stochastics) can come from two elements:
- Divergence: If a divergence in the opposite direction to the trend appears on your trend chart, it is a signal that a correction is likely. I repeat again, correction does not mean trend reversal! Noting a discrepancy is not sufficient reason for opening a position in the opposite direction to the trend. You need to wait until the discrepancy is confirmed and there is a correction. Therefore, look for a bullish/bearish signal on your signal chart that moves in the same direction as the divergence.
- Overbought/Oversold: An overbought indicator does not mean that the price is going to correct! An indicator can remain in the overbought or oversold area for a very long time if the trend is strong. You should therefore wait for the indicator to exit the area to open a position but never before! If a signal is given, then you can look for an opportunity on your signal chart.
- Chart patterns: You have to look for reversal patterns (bevel, double/triple bottom and top, H&S, etc.). The signal is only given when the price validates the figure by breaking the neck line or breaking the lower/upper support (in the case of a bevel). If a chart pattern validation occurs on your trend chart, it is the only case where you do not need to wait for a confirmation on your signal chart.
The chart pattern can also be used to detect a bullish/bearish signal on your signal chart. For example, if you have identified a divergence (or overbought/over-sold area exit) on the trend chart, it is the validation of the chart pattern on your signal chart that gives you the buy/sell signal.
- Japanese candlesticks: Japanese candlestick configurations provide valuable information on investor psychology. You can consult the page "How to identify a trend reversal” on the subject. If a reversal pattern appears on your trend chart, it must be validated on your signal chart. If the configuration appears directly on your signal chart, you can take a position (this being the confirmation signal of a probable correction detected on your trend chart).
- Resistances and supports: Trading against the trend can be done at the level of resistances and supports. But be careful, it is not wise to open a position directly on the level! You should always wait for a turnaround. The resistance or support can be horizontal, ascending or descending according to whether it is part of a chart pattern or not.
First example: A reversal takes place on your trend chart at the resistance level. So you could open a position if you identify an opportunity on your signal chart.
Second example: You have identified a bearish reversal signal (on an indicator or candlestick) on your trend chart. On your signal chart, the price has just turned after testing a resistance. You can therefore open a downward position (against the trend).
- You should always wait for the bullish/bearish signal confirmation before taking a position! Do not expect to buy at the lowest or sell at the highest. With trading against the trend, open a position when a correction has already started, not before.
- Always place a stop loss: Even if there is a clear signal of a counter-trend, this does not mean that the trend will not resume. You should therefore place your stop loss at the level of the highest/lowest that preceded the turnaround. You can move your stop loss as you progress to protect your winnings.
- Cut your trade if the trend resumes: If a bullish/bearish signal is given in the direction of the trend on your signal chart, there is no need to wait until your stop loss is reached, cut your position. You can consult the page, Signals of a trend recovery. There is no point in trying to trade against the trend if all the signals tell you otherwise.
Why trade against the trend?
The reasons that motivate traders to trade against the trend are multiple and are far from being the right ones in most cases:
- Proving they are better than other traders: We're not going to deny it, it's so nice to say "I told you so." And show other traders that we've been smarter or more observant. The feeling of being the only one right is rewarding. It is this excitement that a lot of traders look for when trading against the trend.
Very often, these traders have a longer term vision of their trading. Being right when everyone is wrong in the short term is good but not many people know. If you are right in the long run, the "I told you so" is even more enjoyable. Go on admit it... it's great! And then, if that happens, it only takes one big trade to make a name for yourself in the business (see Mr Belkhayate with gold).
- Feeling the market is oversold/overbought: This is a classic, especially among novice traders. It's gone down or up a lot, it's bound to turn around It's underestimating the strength of the trend, etc. If an asset's price collapses (or soars), there is a reason. A lot of traders raze their trading account by persisting in wanting to be right against the market. Trade against the trend if you wish, but it shouldn't be on a hunch!
- Believing they can earn more: Many traders who trade against the trend say that they take the trend reversal movement right from the start to get higher profits. The problem is that in most cases, the trend does not reverse. You're just going to take a correction movement. If you think that trading against the trend is a way to make a fortune, you're wrong!
- Having a contrary nature: Some traders question every movement. It's going up, why did it go up? Is that justified? It's a good thing to have this approach, but it shouldn't become an obsession either, otherwise you will start a trend of “it's gone up, I’ll sell”. The majority of traders who trade against the trend open a position on a subjective sentiment when, on the contrary, they should be as objective as possible!
How to trade against the trend?
To trade against the trend, you first need to identify the asset’s trend. This is not done on your signal chart (time unit of your trade) but on your trend chart (upper time unit chart). These are the rules of one-way trading. If the trend is bearish on your trend chart, then you will only take into account the bullish signals on your signal chart. Conversely, if the trend is bullish, you will only consider the bearish signals on the signal chart.
An against the trend position should only be opened when there are clear signals. Your reasons for opening a position should be objective and not subjective! The signal can come from an indicator or the price chart.
In both cases, you first need a signal on the trend chart, then look for a buy/sell opportunity on your signal chart. You can use the same detection tools on both your trend and signal charts.
Tools for trading against the trend with technical indicators
A signal on an indicator (I advise you to use the RSI or the stochastics) can come from two elements:
- Divergence: If a divergence in the opposite direction to the trend appears on your trend chart, it is a signal that a correction is likely. I repeat again, correction does not mean trend reversal! Noting a discrepancy is not sufficient reason for opening a position in the opposite direction to the trend. You need to wait until the discrepancy is confirmed and there is a correction. Therefore, look for a bullish/bearish signal on your signal chart that moves in the same direction as the divergence.
- Overbought/Oversold: An overbought indicator does not mean that the price is going to correct! An indicator can remain in the overbought or oversold area for a very long time if the trend is strong. You should therefore wait for the indicator to exit the area to open a position but never before! If a signal is given, then you can look for an opportunity on your signal chart.
Tools for trading against the trend on price charts
- Chart patterns: You have to look for reversal patterns (bevel, double/triple bottom and top, H&S, etc.). The signal is only given when the price validates the figure by breaking the neck line or breaking the lower/upper support (in the case of a bevel). If a chart pattern validation occurs on your trend chart, it is the only case where you do not need to wait for a confirmation on your signal chart.
The chart pattern can also be used to detect a bullish/bearish signal on your signal chart. For example, if you have identified a divergence (or overbought/over-sold area exit) on the trend chart, it is the validation of the chart pattern on your signal chart that gives you the buy/sell signal.
- Japanese candlesticks: Japanese candlestick configurations provide valuable information on investor psychology. You can consult the page "How to identify a trend reversal” on the subject. If a reversal pattern appears on your trend chart, it must be validated on your signal chart. If the configuration appears directly on your signal chart, you can take a position (this being the confirmation signal of a probable correction detected on your trend chart).
- Resistances and supports: Trading against the trend can be done at the level of resistances and supports. But be careful, it is not wise to open a position directly on the level! You should always wait for a turnaround. The resistance or support can be horizontal, ascending or descending according to whether it is part of a chart pattern or not.
First example: A reversal takes place on your trend chart at the resistance level. So you could open a position if you identify an opportunity on your signal chart.
Second example: You have identified a bearish reversal signal (on an indicator or candlestick) on your trend chart. On your signal chart, the price has just turned after testing a resistance. You can therefore open a downward position (against the trend).
The rules to follow when trading against the trend
- You should always wait for the bullish/bearish signal confirmation before taking a position! Do not expect to buy at the lowest or sell at the highest. With trading against the trend, open a position when a correction has already started, not before.
- Always place a stop loss: Even if there is a clear signal of a counter-trend, this does not mean that the trend will not resume. You should therefore place your stop loss at the level of the highest/lowest that preceded the turnaround. You can move your stop loss as you progress to protect your winnings.
- Cut your trade if the trend resumes: If a bullish/bearish signal is given in the direction of the trend on your signal chart, there is no need to wait until your stop loss is reached, cut your position. You can consult the page, Signals of a trend recovery. There is no point in trying to trade against the trend if all the signals tell you otherwise.
