Contrary trading in currencies or any financial market, gives you the best risk to reward but you need to know how to do it correctly and in this article we will give you some tips on the best Forex contrary trading techniques.
What is Contrary Trading?
Contrary trading is simply taking a view which is opposite to the majority opinion and executing a trading signal in anticipation of a trend change. As the majority of Forex trader lose money, this is a trading strategy which works to generate trades with low risk and high reward but before, we explain the basics of contrary trading we need to look at some key mistakes traders make when trying to implement this trading method successfully.
Don't Make this Key Error with Your Trading Strategy!
Many traders look at Forex trends and simply assume the price has gone to far so try and predict a top. There assumption is – the price is to high or to low and sell into tops and bottoms WITHOUT confirming the top on the currency pair first. While the majority of traders lose money, don't just assume that by taking an opposite view, that you will make money – you won't.
The majority can be right about the direction of trends and also, most Forex trends tend to run on for longer than most traders assume so – if you want to be a contrary trader, you need to look for the right set ups which are extremes on a chart and wait for confirmation of a trend change. Correct market timing is the key and you must have confirmation a trend is about to turn before, entering your signal in the market but how do you do this? Lets take a look at some ways to confirm a trend change is likely and how to generate high odds trading opportunities in any currency pair.
Forex Contrary Trading Techniques
Here we will look at some simple contrary trading techniques which you can use for profit.
In terms of spotting contrary trading opportunities, this can be done by looking at the news and also looking at the charts of any currency pair.
In terms of the news you want it to be very bullish or bearish a currency and for the news to say thinks like – there is no end in sight for a trend or it will definitely break a level because this indicates a bullish or bearish extreme is coming. You should also look at if the news is discounted.
If for example, everyone is expecting an interest rate cut, chances are its factored in the price and you have a buy the rumour sell the fact scenario which is when the event comes prices move the other way and set up a correction. You can also look at the CFTC Net Traders positions ( you can read an article about how to read this report elsewhere on the site) This site will give you an indication of how bullish or bearish speculators are and if smart money commercials are selling.
Spotting Contrary Trades on Currency Charts
The charts reflect the conditions behind the move and you will see, an strong trend which is accelerating or a sharp spike higher or lower in price. These spikes, are caused by human emotion and don't tend to last long. You can look at for a trend change but you need to decide, when to place your trading signal and for this you can either use, pure price action or you can use some indicators.
Market Timing at Tops and Bottoms
Markets tend to blow off after price spikes and either have good corrections or trend changes. You can look for a reversal on the charts, with price action and use a number of candlestick reversal patterns, to time your move but personally, I like to use a few indicators and below, are my favourites and their uses.
Bollinger Bands: This is a useful indicator because it show volatility and reversals can happen at high volatility when prices are pressing up to the outer bands, you can look for a reversal.
Average Direction Movement: This Welles Wilder indicator indicates the strength of a trend and a good signal from it to warn of a contrary trend is a move above 40 followed by a turn down.
Relative Strength Index: Another Wilder indicator which is very popular amongst Forex traders and trend changes are indicated at overbought (70) oversold (30) can be used to time a trading signal against the prevailing trend.
Stochastic: This comes in two versions fast and slow, with the latter being less sensitive and both can be used for contrary trading on divergence of the indicator from price. While the traditional oversold level is 30 and overbought 70, I like to use 80 – 20, when looking for contrary trades and if the reading on both lines is above 90 or below 10, the signal is normally more powerful.
Moving Average Convergence Divergence MACD: Probably the most popular indicator for Forex traders andan indicator, where you can look at both the histogram and crossovers on it and the two lines to generate buy and sell signals.
Simple Moving Averages: Price spikes always tend to be short lived and you get a move back to a moving average which is in line with the long term fundamentals and we like, the 20 day and 40 day averages, to use as targets on chart reversals.
I have just listed a few of my favourite indicators above but there are many more and you should experiment with them and mix them, as you see fit to generate buy or sell signals and if used correctly, they will improve you market timing.
Free Your Mind
When trading contrary to the majority, you need to free you mind and think about the news and look at the charts in a detached manor. Its very easy, to be persuaded by the crowd that the trend will go on forever and get nervous about taking a trading signal but don't let this worry you. All big price spikes end and with a simple trading system based upon the points we just discussed you can trade these market turning points for big profits.
Best Trading Tip be Patient
The best trading tip, I can give in relation to contrary trading is to be patient and ONLY trade the best chart set ups. You shouldn't just look at the major currency pairs either – check out the cross rates which can give you some of the best turning points of all. Be patient and wait for bullish and bearish extremes only. With this method of trading its possible with a contrary trading strategy to clock up gains of 100% per annum, trading on average, just once or twice a month.
Don't Worry About Being Stopped Out Try Again
Generally at turning points, your stop loss will be quiet close and you have far more reward than risk and with money management that gives you this, you may miss the first turn but if you think the trend is changing simply wait and try again. Many traders, who get stopped out of a pair, leave it and think they shouldn't try again but there is nothing wrong, with trying again – you simply got your market timing wrong.
Contrary trading is a great way to make long term Forex profits and if done correctly, allows you to trade with low risk reward. If you use the currency trading techniques enclosed, are patient and disciplined you can make a lot of profit, with the simple Forex trading method from home. So think contrary, to the crowd at turning points and learn to trade them like the pro traders do.