You have to admit, the phrase "countertrend trading" itself sounds quite strange, and it's hard to hear. It's like "driving on the wrong side of the road". Is it really possible? It turns out that it is possible, and at a proper professional level this trading system brings a good profit. But first things first. We already know that a trend is a directional movement of the price. We can divide trends into short-term (days), medium-term (weeks, sometimes months), and long-term (years). For example, for the whole year of 2017 EUR/USD was a pronounced bullish trend (this does not happen every year). However, that same bullish year had many bearish days, bearish weeks, and three bearish months (February, September, and October) when the price was going down. We can't be out of work for three months, can we?
The essence of countertrend trading is not to miss these powerful moves against the main trend, to make them work for us, to bring profit. This is not as difficult as it seems.
To do this we must recognize a long-term trend and work against it on pullbacks, i.e. follow the medium-term (or short-term, as the case may be) trend.
What Is Countertrend Trading?
The market cannot always move in one direction (otherwise everyone who guessed the right trend would be a millionaire), it inevitably pulls back a little against the main trend, then goes forward again. Figuratively, it can be expressed as follows: a person makes two or three or four steps forward, one step backward, then three steps forward, two steps backward, then forward again, and so on without end. It's this "backward step" that we're catching the market on.
What is the main difficulty of this trading system? The fact that trends always reverse without warning, sometimes almost instantly (on the news, and sometimes without it), sometimes a little more slowly, but still - no one warns anyone. You have to see for yourself, think, and act.
So, here is the basic idea of countertrend trading:
- We identify the main trend,
- Clearly understand that it can not move forever in one direction,
- We wait for a pullback and take profit on it.
That's it, nothing else. Only in this way, consciously, not "running" after the market, reacting to every fluctuation. It is important not to confuse trading against the trend with the favorite pastime of many generations of investors and traders - looking for a "bottom" or "top" on the charts. In history (history data, quotes archive) it is quite harmless: "Here is the bottom... and here is the top... if I had opened here, then ... and if I had closed here, the profit would have been so-and-so...". In real trading, these searches can end in ruin. The "top" you find will turn out to be an ordinary correction, the price will continue to move upwards. The "bottom" you find in some "third sub-wave of the fifth Elliott wave" will only be a stop on the long way down... Don't look for a black cat in the darkroom, act consciously.
The ability to "flip", i.e. to exit an obviously losing position, cut off losses, and open a profitable one, becomes vitally important for this trading system (as well as for the entire trading in general) for us. Technically - nothing difficult, a few clicks in the terminal. Psychologically, it is a huge difficulty for many traders, especially beginners.
Methods For Trend Detection
After considering what a trend is, it is advisable to proceed to the nuances of its detection. This process is extremely important because a correct understanding of the price direction helps the trader to make decisions regarding buying and selling.
The following methods of technical analysis are used to determine the direction of the trend:
- The use of trend indicators;
- Drawing a trend line;
- Comparing graphs of currency pairs with the same base currency;
- Evaluation of currency pairs' charts (observation of falling, rising, or remaining maximum price positions with every time frame).
Experienced traders recommend that beginners use several methods to determine the trend. It will help to make more accurate forecasts and reduce the risks. As for the strength of the trend, it is better to determine it using the ADX indicator built into MT4. A value below 20 signals a flat and the need to wait, 20-25 is the ideal time to enter the market, and 50 and above indicates the imminent change of trend, so it is not worth it to start trading.
How To Trade Against A Trend
It is important to understand that the support and resistance lines are set at the extremums (maximums), and prices for a certain period of time. The higher the time frame, the stronger the lines. More precisely, the price is more difficult to break out. Have you noticed that the price often comes back to the same place? It means there is a strong level! And the trader may use it to make a profit. It may be a countertrend trade or a continuation trade.
It was relying on these levels that most traders use. How do they do it? The support level is placed under the price as if supporting it and not allowing it to fall lower; A resistance level is placed above price, again, as if resisting price, preventing it from going even higher. If the price breaks out some line, it is changed into the opposite one. That is if the resistance line is broken out, it becomes a support line until the price breaks it out again.
But if the levels are strong enough, the price kind of wanders between them. The normal rule for trading on lines is to enter the market if the second candle opens with the same color (in the direction in which we are going to trade): Maybe it seems complicated at first, but with a little practice and you will easily navigate and understand what to do.
Indicators For Countertrend Trading
Perhaps the most common indicators for trend analysis and correction are:
- Moving Average – trend indicator;
- RSI (relative strength index) – determines the strength of the trend and the possibility of its change. Also, its readings show overbought-oversold areas.
- Someone uses MACD indicators, Parabolic SAR, Bollinger lines, and others...
For our part, we can say that in order to determine the trend and when to trade against the trend, the indicators may not even be necessary! Although, if you find them easier to use, then RSI would help you the most. Support and resistance lines are also indicators, and most traders find them helpful.
Common Mistakes When Trading Against The Trend
Usually, when a person looks at a chart, his eyes unintentionally "cling" to the extremes, then he estimates the scale of movement after the maximum/minimum and comes to the conclusion that countertrend trading is exactly what is needed. In fact, this is nothing more than a dangerous delusion. The problem is that a person quickly looking through the chart does not see a lot of entries against the trend, which would be unprofitable. These signals are simply lost in the background of history, but if we analyze any trend in detail, there will be a lot of such entries.
Typically, before a reversal or the beginning of a more or less serious correction, an appropriate candle is formed on the chart, and it would seem that you can trade only on these signals. The problem is that before the reversal, several such candlesticks may form, and each of them will trigger the set Stop Loss.
Suppose that a Doji is formed on the D1 chart after a long uptrend (i.e., the bulls and bears were about equal that day). The trader opens a short position at the closing price of the candle, the Stop is placed behind its extremum. But the next day the market is again uncertain, and the trade fluctuates around zero. The same pattern is repeated the next day, but the price triggers the Stop, updating the extremum. In this example, it would be better to trade countertrends using pending orders. It would be logical to place a pending order 15-20 points below the Low of the first Doji. This small insurance would allow avoiding losses. But this entry can still be considered risky since there were no other signals for the entry except for the Doji.
Even worse is the situation when the chart consistently gives false entries several times. Many traders, especially beginners, increase a lot in such situations in an effort to win back the losses which result in losing most of the deposit. In the example above, greed forced the trader to trade immediately after the Doji is formed, without waiting for confirmation of the signal. It caused loss and, taking into account the increasing lot, the losses become even more significant. But the considered examples do not mean that entering against the trend is doomed to failure. You just need a few confirmations of the received signal, but even in this case, the risk will be high.
How To Protect Yourself When Trading Countertrends
If countertrend entries are used only as an addition to the main trading system, then you can use a few simple rules, on the observance of which the chances of success will be greater:
- It is desirable that the point of a potential reversal/the beginning of a correction coincides with a strong level. Levels can be looked for in a higher time frame, and Fibonacci levels built in a higher time frame can be used to find support/resistance;
- There are cases when the level is not tracked on the history, but it is evident from the chart that it begins to take shape, in which case it is better to enter by pending order. In the example above, the price entered an expanding triangle on the top of the trend, we could sell either at the breakout of support (line 1-3-5) or by a pending order, it should be set 20 points below point 3;
- The divergence strengthens the received signal;
- It is necessary to consider the nature of the price movement, the chance of a correction is greater if the movement was sharp, it is characterized by large candles with small shadows. The price may simply lack the strength to break it at the first attempt, so at least a correction is possible;
- The graphical patterns reinforce the received signal;
- If the uncertainty in the market remains for 7-10 candles after the signal is formed, it is better to close the transaction manually or move it to Breakeven.
Attention should also be paid to price behavior. Sometimes during sudden bursts of activity, a candlestick with a big body is formed (especially noticeable on small timeframes), which breaks through resistance/support, but then a strong pullback occurs, and the candlestick eventually closes with a big shadow.
Most often in such situations, it moves in the direction of the pullback and there is a chance to take at least 30-50 pips. Although, there are bad moments when the price is moving with a large swing for 2-3 candles and just takes off "extra passengers".
Intraday Countertrend Trading
You may try to trade based only on the average daily price range. The method consists in calculating the average daily price movement and entering a trade against the price movement for the day when it has passed most of the average price movement. Suppose the price moves on an average of 100 points a day. If it has moved 80-90 points in one direction during one of the days, then it is possible to move in the opposite direction expecting a slight pullback. This approach works only in a relatively calm market, unexpected news can break the whole picture.
The volatility of any currency pair can be calculated independently using an ATR (Average True Range) indicator. The number of candlesticks to be averaged is set in the settings. The average volatility value for any day can be calculated simply by moving the cursor onto the indicator curve.
You can use the online services, the calculation period is set, the currency pair is selected and then the price trend in pips is displayed by day and by the hour. For example, EUR/USD passes about 110 points a day in April, since part of the month falls on holidays, you can add 5-10 points and finally assume an average daily range of 115-120 points. As soon as the price passes about 80-90% of the average value during the day, you can enter the market. Usually, a Stop Loss of 20-25% of the average price volatility should be enough, Take Profit should either be twice as big or not used at all.
The disadvantage of such countertrend trading is that the daily price volatility can be much higher than the average value calculated for a couple of months. Setting a standard Stop Loss in such a situation is a guaranteed loss and unexpected news can cause surprises. Too much in this approach to trading depends on luck, so you should not count on serious earnings.
What Are The Benefits Of Countertrend Trading?
Well, you all know the expression "The trend is your friend". But what to do if trend movements are only 20-30% of the time, and the rest is flat? What to do in such situations? Yes, if we can distinguish some fluctuations on the chart, clearly resembling a trend and moving in a channel near the trend line or moving away from the moving average, we can trade in its direction. In cases when the market is moving up and down without any clear direction and we have to wait for a new trend to form, it is possible to miss an opportunity to make a profit. Such conditions on the market can last several months. In such situations, it is necessary to trade cautiously against the main market directions. The following strategies are suitable for this purpose:
- Trading on pullbacks. A strong trending price spike is usually followed by a correction, which can be used to make a profit. Often such an event occurs during the publication of important economic indicators. At these moments, the price makes a sharp jerk in the trend direction, after which it rolls back. The use of such events occurs during trading on the news by traders. They catch the first movement on the news, fix profit on it and immediately reverse the position when the movement has exhausted itself. Thus, they significantly increase their profits. Also, the price is corrected when the American trading session is closed, and it can extend to the Asian session. When planning to trade on a pullback, you should remember that the correction is always less than the trend movement. That is why you should calculate Take Profit on the basis of the minimum goals.
- Scalping. Scalping strategies involve using any movement to trade regardless of the direction of the trend. Traders earn scalping small take-profits on short-term trades (no more than 5-10 minutes), which allows them to trade in the direction of the trend as well as against it. Profit is achieved by making a large number of trades per day.
- Trading inside the channel. The price movement in the channel during a trend occurs both in the direction of the trend and against it. Using borders of the channel as reference points for transactions opening, it is possible to trade regardless of the trend direction. The main difference in such trades will be the size of Take Profit - against the trend it will be smaller than following it.
- Trade on the basis of oscillator indicators. You can also use readings of oscillators in your trading, selling when the oscillator exits the overbought area and buying when it exits oversold areas.
- Pivot points on the chart. Various reversal patterns can also be used to trade against the trend, signaling the end of the current trend and the emergence of a new one. Taking advantage of such moments you can catch the beginning of a new trend and get huge profits. Of course, such moments are rare enough on the chart and can mean a big loss if the trend continues. To avoid sudden triggering of Stop Losses, at the expense of an unreasonable entry, it is recommended to follow the recommendations described further in the text.
Countertrend Trading Tips
To succeed and profit from trading against the direction of the main trend, it is necessary to keep a close eye on the following points:
- Trades should only start trading from support or resistance levels. If there is a reversal pattern on the chart, for example, a pin bar, then before opening a trade one should pay attention to the support in the form of a price level, trend lines, Moving Average, Fibonacci retracement, etc. If such a level is not found, it is one hundred percent sure that the price will continue to move.
- Levels in high time frames. For example, if you see a reversal pattern near a level on the four-hour time frame, it is worthwhile switching to the daily time frame to see if this level is there too. If there is no level, it makes sense not to enter the market.
- The presence of reversal patterns. Using the reversal patterns (head and shoulders, double and triple bottoms and tops), price action models (pin bars, the rail), and other models, you should always check the presence of levels in the places where they occur. The presence of a strong level indicates a good opportunity to open a trade against the trend.
Confirming signals. Before opening a position it is necessary to wait for the confirmation signal, such as retesting the level. The retesting of the level looks as follows:
- Price reversed against the trend near the level;
- Several candlesticks with the same high or low appeared.
Such candlesticks indicate the presence of a strong resistance, which can be used to open a trade. In such cases, it is best to use limit orders, placing them near the level with a small Stop Loss.
- Short Take Profits. When trading against the trend, you should always remember the short duration of the correction, so the Take Profit size in such a trade should be small and focused on the nearest power level.
- Use of pending orders. When trading against the trend, pending orders should be used to ensure your trades against the trend. By placing them in the direction of the trend, you can cover the loss from a bad trade.
A long tail on a news candlestick. The presence of such a tail on a candle, closed after the news, indicates the preponderance of bullish or bearish forces (depending on the candle). For example, before the news broke, there was an uptrend and the price went up, and after the news release, it went back down sharply, leaving behind a candlestick with a long tail. Having seen such a candlestick you should place a trade against the current trend because after such a tail the price will be falling for some time. In this situation, a Stop Loss should be placed above the level of the tail of the news candlestick, to avoid closing it on a spike after the news. Take Profit should be even larger because in this situation the price then often goes a considerable distance against the trend. This phenomenon is the most suitable for the countertrend trade because it works with 100% probability.
Countertrend trading requires a higher professional level than, for example, trend trading. It cannot be left to chance, it requires more attention, i.e. time. If, when trading along with the trend, it is even useful sometimes to switch off the terminal and quietly let the profit flow, then it will not work against the trend. You must constantly "keep your hand on the pulse" of the current market situation.
The above (increased attention) should not be expressed in vanity, it is essentially different things. One of the first signs of professionalism, that you already understand something in the markets, is the awareness that prices which seem to move very quickly, in fact, move slowly. Do not be fussy. If you act correctly and follow risk management, you will have plenty of time to "rollover."
Learn to "flip" in a demo account, ideally, you should bring this most useful skill to automatism. In online mode, on different currency pairs, on powerful movements (they often occur on the news) - open against the trend, with a significant price movement in the opposite direction ( for example, 150 pips) - open along the trend, gradually reducing loss-making positions until their elimination. Do not try to monetize, to make a profit on every market fluctuation, you will not succeed. Take some profits on the obvious trend - that's our task, quite realistic.
Bottom Line
Countertrend trading is a rather risky method of making money as it is very difficult to identify the reversal point precisely. On the other hand, if the circumstances are lucky, it is possible to make a large profit on correction or even to catch a change in the trend. It is better to forget about this trading style for beginners. Only when profit on the currency market becomes commonplace one can try trading against the trend.
But it can hardly be recommended to use this trading style as a basic one, taking into account risks. It is possible to consider trading against the trend only as an addition to the main trading system. If ideal conditions for entering the market are formed, it is possible to risk and enter with a small lot.
It is believed that trading against the trend is the least risky and most profitable. But what to do when trading against the trend is to your taste? We advise beginning traders to stay away from such desires - they will bring you nothing but losses. Maybe you will be lucky once, but future Stop Losses can quickly eat up your deposit. For experienced traders who like intraday, we suggest trying countertrend trading, while making sure you follow all the recommendations.
