Trading with the trend is a viable part of any trading strategy but keep in mind that the trend will end.
As a trader, it does not hurt to have a few “tricks” up your sleeve to be able to tackle different market environments.
Counter trend trading is something you can do once you see a sign that the trend move, the impulse move, is running into issues.
Going back to the basics of a trending market, we have the impulse or momentum move and we have the pullback in price. Understanding this structure and the clues it gives you, can really improve your trading results
Stair Stepping Trend Pattern
Virtually every chart you will ever see will have a pattern similar to this at times. It’s standard price structure in a trending market where, in a uptrend, the impulse moves are larger than the pullbacks.
You can see a rhythm in price and nothing interesting is going on except an orderly advance in price. Traders that are focused on the up trend, would trade the ending of a pullback or a breakout to new highs.
In this graphic, there is nothing suggesting that counter-trend trading is the play to focus on although there are always those people that will attempt to short any pause in the upward trending action.
Those people love to attempt to capture the top or bottom of the market but end up adding to a losing position and taking larger than necessary losses.
Counter Trend Trading – Trade The Reversal
There will come a time when price will run into issues during the advance and it is during these times that a counter trend trade may present itself.
We have price “going parabolic” or even breaking into a range after a sharp move upwards. We have a change in state compared to recent price action and this should have a trader paying attention.
Time To Short?
If high probability trades are your interest, counter trend trades right now may not be the proper play. You don’t want to just short a pause in price but would need to see further price action to show that the bulls have lost their steam.
Often times what can happen after these moves is price simply consolidates as shown in the graphic, works off the overbought condition, and starts to work its way in the direction of the trend.
The best play right now is no play.
You probably would not want to trade the first pullback after this type of move due to the extreme state of the market at this point.
We need to see other things occur.
Strong Pullback in Price
Price had printed an interesting event to the upside and now, price prints an interesting event in the pullback.
Compare the lengths of pullbacks and you can see that the last pullback is much more violent and larger than any of the previous. This indicates much more selling pressure than this trend has previously encountered.
- Are the big players showing their hands?
- Would you be looking for a long position at this point?
Hopefully you said you would need to see more evidence of upside potential but at this point, buying into this market is not a solid play.
How about shorting?
Let’s look at what has occurred.
- There was an orderly uptrend of price
- Price began to print a parabolic move which should put you on alert
- Price began to consolidate in a trading range
- An “out of character” pullback has occurred
Tying that all together, now there is a bigger potential of at least another correction in price which you may want to get involved in to the short side.
Price Correction or Counter Trend Trades
If you trade pullbacks in trending price action, one thing you look for is intent in the upward move. The reverse is the same if you are trading a down trend – you want strong impulse legs going short.
Looking back at this graphic, we actually have a strong move in price to the downside which fulfills our condition of strong impulse legs. It is possible that this is a major trend change and shorting the first pullback can be a great trading play.
We don’t know if this is a change in trend but we can certainly short this market and be conservative with price targets or risk.
Depending on your time frames, you may have to drop a time frame or two lower to actually see this structure play out. Larger time frames can often hide the details that you are able to capitalize on.
End Of Trend Example
As price advanced on this chart, the first three pullbacks in price are virtually identical in terms of distance. The last pullback has a different “look” to it and is the largest pullback in this current move up in price.
You can see that price had a strong push up , reversal type of candlestick, and then momentum drove price down. This is the type of price action you want to see if considering taking a trade counter to the prevailing trend.
Counter Trend Trade From Consolidation
There is a way to potentially take advantage of a market this in consolidation after a big price run. Although consolidations at the highs of momentum are generally hinting to further trend direction, there is a pattern we can look to trade for a counter move.
When a market moves with momentum and consolidates, I am still biased in the direction of the momentum thrust. However, if during the consolidation I see price test the extremes at highs and fail, I consider position for a breakdown from consolidation in the opposite direction of the thrust.
You can see in this graphic where price pokes above highs and is rejected. As higher price were tested, they were rejected and this tells me that the probability lies with demoralized buyers and profit taking can ensue.
Add to those who play breakouts and get their stops hit, and those wanting to pile in short (including demoralized buyers), I look to enter and watch price action to ensure adverse moves against my position are acted upon.
It’s About Probabilities
Remember that trading is about putting the odds on your side and trading in the direction of the higher probability move.
Counter trend trading just for the sake of doing so, is not an edge.
Understanding price action, what the moves mean, and taking advantage when price is hinting at the next move, is smart trading. At all times, ensure that risk management leads the way in any trade you take.