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Contrarian trading

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Contrarian trading

September 20, 2018

In the world of Forex trading is only a matter of being right or being wrong. That’s all that is.

This is a dog-eat-dog world, with real people trading for real money. More importantly, this is not a video game, even though many think it is.

The problem comes from the way retail traders approach the market. Most of the retail people come to the market having wrong expectations.

Moreover, they treat trading as a hobby. As such, they don’t put in the time needed to succeed.

If you ask any retail trader why he/she is willing to put the capital at risk, and most of them will answer that they want to have an extra income.

Which, in a way, is true, but the market is merciless. No one has anything with anyone, and a stop loss or a margin call gets triggered in a blink of an eye.

Over eighty percent of trades come from automated trading. Either placing a stop loss/take profit or pending order or effectively trading with algorithms, execution lacks the human touch.

This is both a blessing and a curse. On one hand, it is a blessing as traders get to be filled at more accurate prices, for example. On the other hand, if you are to be stopped and receive a margin call, praying won’t help: the market will merely trigger the order, and you’re out.

Reality Behind Numbers

The truth behind numbers speaks for the risks in this area. Over ninety percent of retail traders fail on their first deposit. This is something!

Many of them won’t continue anymore. But most of them will and continue to struggle. Few make it trading for a living.

Lack of education is a reason. Lack of time to allocate to this market that changes continuously is another.

In any case, doing what most of the traders do won’t do the trick, right? If most of them fail, why following the crowd?

There is even an “indicator” called COT or the Commitment of Traders. What is it good for, you ask?

For one thing, and the most important one, it shows the “crowd” direction. And, by the crowd, I mean retail traders.

If most of the crowd is, say long the EURUSD pair, but, statistically, they will fail in the end, then what is the most likely direction the market will go? Not long!

Introducing Contrarian Trading

This is a concept for the brave ones. Conservative traders will have a hard time using it, but aggressive ones will love it.

The example above, explaining the COT concept, represents one way of dealing with contrarian trading. However, it is not the only one.

Ever thought of an oscillator? Why buying in the oversold areas, like everyone is doing, if everyone will fail in the end? Why not selling? This is just another form of contrarian trading.

Another example comes from trend traders, despite this sounding crazy. Trend traders fall into two categories:

  • Conservative traders – these traders wait for every indication that a trend reversed, and they wait for the new one to start, and until “all stars aligned,” they won’t open a position in the new trend’s direction.
  • Aggressive traders – these guys love risk, and reversal patterns. But trading with reversal patterns, isn’t it contrarian trading? Basically, what they do is fading the primary move.

Using the same logic, a pattern recognition approach to trading tells us that any reversal pattern represents contrarian trading. Japanese candlesticks techniques, for example, fall into this category because most of them are reversal patterns. Here are a few:

  • Bullish and bearish engulfing
  • Morning and evening star
  • Doji candles
  • Hammer and shooting stars
  • Dark-cloud cover and piercings

But that’s only the Japanese approach to trading. Patterns that belong to the Western approach show the same thing. However, by the time these patterns show a reversal, most of the contrarians already ride the same wave.

Fundamental Contrarian Trading

Contrarian trading isn’t exclusively a technical thing. Believe it or not, fundamental traders using too.

The big difference is that fundamental traders (the ones that interpret two or more economies, find the difference between them and buy and sell their currencies accordingly) belong to a different category: they’re mostly macro-traders, and, as such, don’t fall into the retail one.

This gives them a massive advantage because they have better resources to use, access to a lot of expensive research and so on. It makes them untouchable in the face of adverse winds and offers them a competitive advantage in front of other traders. That competitive advantage is time.

For a macro-trend to turn, time and execution may not sync. Most of these traders get early into a trade. However, they have the power to wait for the turn, even if this means a few months or even a year until the market efficiently turn.

The best example these days come from the interest rate differential between the United States’ Fed and the ECB (European Central Bank). The first one is in the middle of a tightening cycle, with the interest rate on a steep rise.

On the other hand, the ECB still has negative interest rates for the common currency, and no tightening plans yet.

Still, the Euro rose against the U.S. Dollar for most of 2017 and keeps higher values. In fact, the most successful trade last year was to be long EURUSD, despite all odds.

Isn’t it this the perfect example of how contrarian trading works? When everything points to one direction, and yet the market moves in the exact opposite one?

For this reason, there is no real rule when it comes to contrarian trading. As mentioned earlier, it is a dog-it-dog world, and either you have it, or not.

As always, information is critical, and a bit of courage helps too. On top of these, patience and the ability to spot the right trade will make any trader ignoring the crowd. That’s contrarian trading at its best!

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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

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