One of the first advices beginner traders receive is that they should never trade against the prevailing trend. This is a sound idea. However, if you have been trading for a while, you have probably wondered if there is some room for being creative about it.
Indeed, with a technical analysis tool called equidistant channel and some experience, you can trade against the trend and become quite successful.
If you carefully study the price chart of any asset, including Forex pairs, you can observe that most of the time the price of the asset remains within range. However, even when the asset is trending upwards or downwards, the price would often create an upward or downward sloping range instead of consistently moving in the same direction. If you can identify the “range” of the trend, you can apply additional technical analysis to pinpoint a good short entry around the upper end of an uptrend. Similarly, you can also find a good long entry at the bottom of the range of a downtrend. Equidistant channels help us develop a trading strategy with this exact principle.
In a nutshell, an equidistant channel is made up with two parallel trendlines. While advanced charting software like MetaTrader 4 has a built-in tool to draw the equidistant channel, you can draw the it on most charting software by manually drawing two parallel trendlines.
Figure 1: Draw Two Parallel Trendlines to Create an Equidistant Channel
During an uptrend, just draw an uptrend line by connecting the lower highs, then draw a second uptrend line by connecting the higher highs of the trend. Likewise, when drawing an equidistant channel on a downtrend, you just need to connect the higher lows to draw a downtrend line, then connect the lower lows, and voilà! You have successfully drawn yourself an equidistant channel and ready to trade against the trend!
Before you endeavor to start selling at the top of the equidistant channel or buy at the bottom, keep in mind that this could turn out to be an extremely dangerous way to trade the market. If you are not careful, you will often find yourself selling at the very moment when is price starting to go down like a falling knife and vice-versa.
Hence, first, you need to identify the perfect market condition, where the trend is likely to change course and may start a significant retracement move. After all, you are trying to trade against the trend, not trying to enter the market at whim randomly.
There are several ways you can identify if the asset you are trading is likely to start a retracement, besides the obvious fact that the price of the asset is trading at the opposite end of the channel resistance.
Figure 2: Look for Divergence While Price Is Trading Near the Channel Resistance
Combining the power of divergences with the equidistant channel is one of the easiest ways to determine if the price of any asset is about to start a major retracement. While there are several technical indicators out there that you can use to identify a divergence, we found the MACD indicator with default settings pairs best with equidistant channels.
For example, in figure 2, you can see when the price of the USDJPY started reaching near the top of the equidistant channel, the MACD made a lower high compared to its previous peak. As the price moved higher, but the MACD failed to create a higher high, it constituted a regular bearish divergence that indicated the USDJPY price is likely to start a bearish retracement towards the lower end of the equidistant channel.
Besides finding divergences around the equidistant channel resistance, you can also combine price action triggers to enter the market. In fact, we highly recommend that you use a third confluence to confirm and trigger your market entry.
You see, the confluence of the equidistant channel and MACD divergence can be sufficient to warrant a trade. However, these two technical analysis tools only provide an area of the potential reversal point. Briefly, this confluence only indicates if the price is likely to reverse or not, but it does not give us a signal or confirmation that price has essentially started the reversal.
Moreover, you do not want to enter a trade based on probability alone, especially, when you know you are trading against the trend! You want a concrete signal that the price started the retracement process before entering the trade, right?
This is where a price action bar like a pin bar or engulfing outside bar can help you pinpoint your market entry.
Trading against the trend is never easy, but if you learn how to accomplish this successfully, you can enter some great trades with a phenomenal risk to return ratios.
While you are lured by the idea of trading against the trend and covet such trading opportunities, keep in mind that this particular style of trading against the trend is not for everyone.
When you are trading with the trend, usually, your win rate would be very high, but your risk to reward would be likely lower, partly because you are entering the trade after the market has moved quite a bit in a particular direction to establish the trend.
However, when you are trading against the trend, you are selling at the top, and buying at the bottom, long before the downtrend and uptrend have been established, respectively. Therefore, even after applying the confluence of equidistant channels, MACD divergence, and waiting for a price action confirmation, your win rate would be very low.
Having said that, you would still likely end up making more profit by trading against the trend with a lower win rate, because your risk to reward ratio would be very high with this strategy.