Why is it that so many advisers tell us to trade with the trend? Isn't that what everyone does, and doesn't that mean that we can't expect to get those exceptional returns that elude most traders?
'Let the trend be your friend' if I could have a dollar for every time I've heard that, I wouldn't still be a struggling trader, I'd have retired by now. But of course, you don't want to buy into a position that's in a continuing downtrend, or sell short in an uptrend that won't give up, so how do you trade against the trend?
I think there are two times that you might consider going against the existing trend. One is when you have seen signs that there is going to be a reversal. This is obvious, but the reversal signs may not be. If they suspected a reversal, most traders would watch carefully, and only take a position when the price starts going the other way.
But so many of the technical tools we use lag the price action, so to spot a reversal in advance requires as much luck as judgment. An indicator running counter to the trend does often give as a warning in advance, but is no guarantee that the reversal will happen. Taking a 'guess' that a reversal is around the corner is risky at best.
The other time you may trade against the prevailing trend is perhaps not so chancy, but is limited in its returns, and won't give you much more than safer general trend following systems. You can trade against the prevailing trend when you have a solid trend, have drawn the trendline and a channel line, and the price is bouncing between the two in copybook fashion.
When you have this situation, all you need to do is keep an eye that the trend is continuing strongly and you can take advantage of the inevitable pullbacks, as well as riding within the channel in the direction of the trend. It's useful to bear the Elliott Wave Theories in mind, as the five waves up and three wave correction should play out fairly well in a well behaved security.
The only question then is why you would want to trade counter trend when you know that the returns are limited by the size of the channel, and that it is a riskier proposition than trend following. If you can make a steady amount by following a trend, then why would you consider counter trading in a channel?
I think that many traders get to a point in their education when they are sure that they can read the market, and feel that they can foresee the reversals, which would give larger returns. What they fail to see is that the market will always win. It doesn't have a bank account that can run out, and couldn't care less what you think it 'should' do. Trading against the trend? Only if you're careful!
The content of this site is Copyright 2011 Contracts for Difference Ltd. Please contact us if you wish to reproduce any of it