Trend following strategies are widely used by traders to find entry opportunities and benefit from the price changes of the asset. Trading “with the trend” is a popular approach, however, there are many possibilities to be found in the temporary corrections of the price as well. To profit from them, traders can apply the counter trend trading strategy.
The counter trend strategy is an approach used on short and medium timeframes, where traders catch moments of temporary trend reversals and open deals to potentially take advantage of the correction. Focused on smaller profits, traders usually open multiple short-term trades to target the price reversals. The convenience of this approach is that it can be combined with the trend-following strategy. Which means that a trader can make more entries within the same asset.
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What Is Counter Trend Trading?
Counter trading is an approach that involves opening deals against the overall trend of the security.
To understand how this method works, have a look at the USD/JPY chart below.
The asset is in a strong bullish broader trend over the course of a week. However, short-term bearish pullbacks form regularly, giving the chance to profit from the reversals. To do so, a bearish deal can be opened each time a reversal is expected, with a stop loss level set to protect the position from a higher than anticipated loss.
Traders that apply the counter trend trading strategy often hold multiple positions at the same time, maximizing their potential gains. The counter trend strategy is similar to swing trading, where traders catch small market movements and build a larger revenue from small gains.
Counter Trend Strategy Advantages
- More entry opportunities: traders get the chance to benefit from short-term trend reversals.
- Fast pace: no need to wait for a big move to enter the market.
- Compatibility with trend-following strategies: traders can hold numerous positions to profit from all the price changes of the security.
- Works with any instrument: use the counter trend trading on Forex, stocks or cryptocurrency.
Disadvantages of Counter Trend Trading
- Requires more time and effort due to the increased amount of trades.
- Requires careful technical analysis for timely entries and exits.
- Potentially higher commissions if your broker charges fees for opening trades.
How to Use the Counter Trend Trading Strategy
Building a counter trend strategy involves several steps.
First, choose an asset you wish to trade. Avoid highly volatile assets as it may increase the chances of your stop loss level being triggered.
Then, pick technical analysis tools to locate the potential reversal points. To do this, indicators like the Moving Average or the RSI can be used. Additionally, you may look for reversal candlestick patterns in order to confirm the signal.
Once the entry signal is confirmed, it is important to apply the necessary risk management tools. Take profit and stop loss levels should be set to help manage the outcome.
Counter trend traders have to be prepared to exit immediately if the predicted reversal does not happen.
Example
Let’s look at the practical example of the counter trend trading strategy. The example below shows the 15-minute price chart of the AUD/USD currency pair. The asset is in a bullish broader trend, with several bearish reversals illustrated.
The price action starts with a bullish trend, then the RSI indicator displays a reversal signal. The reversal is confirmed by the first bearish candlestick, which means that a bearish position can be opened.
A stop loss is placed above the top of the created bearish candle. The RSI follows the reversal until it indicates a potential reversal to the bullish trend again. This signal is confirmed by the next green candlestick, at which point the trader has to exit the trade. This sequence is repeated at the next pullback, with a longer downward trend.
Who Can Use This Strategy?
Counter trend trading is not considered an “easy” technique and therefore it should be extensively practiced first. This approach can be used by traders that prefer shorter timeframes.
It is important to follow the trading strategy closely and implement the necessary risk management tools to limit the potential losses as much as possible. High risk tolerance and the ability to control strong emotions are the key characteristics of a counter trend trader.
