How many times have you heard the trading cliche that you should never trade against the trend?
My guess is enough times that through osmosis this bad advice has unwillingly seeped into your subconscious and stopped you from trading profitable countertrend setups with the frequency that you should be trading them. Let’s correct this major problem right now.
In this article I am going to quickly lay out the problem and hand you a solution that will make you a countertrend master. Do not mimic most lazy traders by nodding your head and then forgetting about everything you read today. I want you to put the strategies into practice, track your results and show them to me once you have a good sample size.
Fear of Trading Countertrend Setups
Most traders fail at countertrend setups because they are bad traders who are too lazy to truly understand the setups. I know this is a harsh statement, but the harsh reality is most traders don’t know enough to effectively trade. The truth is the setups are strong and profitable. It is the traders who are not.
Bad traders are afraid to trade the countertrend setup because they have been burned time after time by making a combination of the seven cardinal sins for trading countertrend setups. Bad traders guess the entry without a signal, trade too big, exit without a sound plan, add to the position when it goes against them instead of stopping out, ignore the stock after it doesn’t work the first time and lack understanding of the initial trend catalyst.
Consequently, losses derived from these common mistakes make them think trading against the trend is dangerous, when in actuality it’s just bad trading. These traders should stop blaming the setup, blame themselves and fix the problem.
Following the seven strategies laid out below makes it almost impossible not to win at trading countertrend setups. If you put these rules into practice, countertrend trading will become and important tool in your trading arsenal and supercharge your profits.
7 Strategies for Trading Countertrend Setups
- Understand Price Can Go Higher Than You Think. Keep in mind that a stock up 100 percent can easily move much higher than you think. For instance, stocks that show parabolic momentum have no business pricing at these insane levels, but continue to go up as shorts continue to squeeze out of the stock. On the flip side, stocks in free fall often fall until the last of the sellers all sell together, created in “capitulation” selling event.Wait for price action to tell you the move is over and never guess that the move is over.
- Wait For Precise Entry Signal. Building on the first point, patiently watch all those shorts get squeezed out of their positions and only enter once the stock gift wraps you one of the specific entry signals we look for in a countertrend setup. This is dependent on the setup, however we are usually looking for a reversal candle pattern or failure of a key level.
- Risk Less. Countertrend setups are seductive, giving traders visions of hitting the lottery on the reversal. While you can make big gains, never forget that you are going against a powerful established trend. Even with a great entry signal, the trade doesn’t always work. When it goes against you, it sometimes is off a big gap that can crush your trade. For that reason, go on the defensive and trade smaller.
- Don’t Guess The Exit. While we’ve focused on the entry, the exit is actually the hard part. How far will the countertrend setup go? The truth is we don’t truly know. To stop us from guessing and likely taking small profits that keeps us from trading the setup optimally, use logical support and resistance levels as targets and scale out of the trade. This keeps you in the trade when there is a big move.
- Never Average Down. If you don’t follow this rule, you will crush your account. Notice that I did not say “might”, I said will. Many traders add to a losing countertrend position because “it has to reverse at some point”. Don’t give in to the temptation. If your hope does not pan out, it’s too big of a loss to come back from. Instead, stop yourself out with a small loss and follow the next tip.
- Re-enter The Trade. When you stop yourself out for a manageble loss, don’t be afraid to enter again if the stock becomes even more extended and again gives you an entry signal. Too many traders feel burned by that initial small loss and take the stock off the watchlist. Everybody is watching the first trade, and the weak hands leave once it doesn’t work out. For that reason, it’s often that second move that’s the big win. Some of my biggest wins have come after I lose out on the first trade.
- Understand Why The Stock Made The Initial Move. The setups and patterns we trade are based off market structure and human psychology, not because the pattern looks pretty or shows geometrical symmetry. Take the time to understand they “why” of the move. This will give you insight into how to trade it. For instance, if the move was based on a likely short-lived news event and has a high short interest, you know the odds are in your favor that once the event is over the stock will tumble down. However if the company blew out earnings and shows monster growth, your countertrend short opportunity might now be quite as possible.
The Countertrend Setup Trading Challenge
If you follow the 7 rules for trading countertrend setups, you should see explosive growth in your profitability trading against the trend.
Now I want you to put these rules into practice by doing the following.
- Scan for the most overbought and oversold stocks in the current market.
- Put them in a watchlist.
- Monitor the watchlist daily for strong setups.
- Paper trade them based on the tips listed in this article
Track your results and post them here in the comments, on my facebook page or via e-mail to firstname.lastname@example.org.