Forex Counter Trend Trading Strategy: Ultimate Guide For Beginners

What Is a Counter Trend Trading Strategy？ 

Counter trend trading is a strategy aimed at generating small profits by trading against the predominant, larger trend. This approach is a type of swing trading strategy that seeks to capitalize on reversals that occur within an ongoing trend. Typically, counter trend trading is a medium-term strategy where positions are held for several days to several weeks. 

How Counter Trend Trading Works？ 

A counter trend trader aims to spot indications of a possible shift in the trends direction before putting this method into action. To identify when a trend is losing steam and is expected to reverse, they frequently employ technical indicators such as moving averages, oscillators, or chart patterns. Once a possible reversal has been detected, a counter trend trader will initiate trade in the opposite direction. To reduce potential losses if the trend persists, stop-loss orders can be used, while take-profit orders can be used to secure gains if the trend changes. 

Traders using the countertrend approach look for reversal candlestick patterns like pin bars, morning or evening stars, and use oscillators such as MACD or RSI to determine if the market is overbought or oversold and whether there is a divergence between the price and the indicator. If these signals are present, traders open positions that go against the previous trend.

A smart trader can incorporate pullbacks into their trading strategy while maintaining their primary positioning in the direction of the trend. Conversely, those who employ a countertrend strategy rely on indicators such as momentum, support and resistance levels, and candlestick patterns to identify potential market entry points. Nevertheless, traders should be cautious as the trend may resume at any time unexpectedly.   

Trend Trading vs Counter Trend Trading 

Trend trading involves buying in uptrends and selling in downtrends, with the ideal entry point being the end of a correction. On the other hand, counter trend traders sell when the price reverses from resistance in an uptrend and aim for support, anticipating a decline after the price has peaked. 

The concept of ‘Trend trading’ has its own benefits, and at first glance, it may seem like the only sensible way to trade. Who would want to purchase a currency pair that is losing value or sell it when it is gaining value？ For trend traders, seeing an asset increase in value is a clear indication to buy. The likelihood of failure is low since the currency pair is riding the momentum. However, following the trend often does not provide any distinct stop-loss or take-profit opportunities. Ensuring that a trade has a reasonable risk-to-reward ratio can be difficult. 

The concept of ‘counter trend trading’ may seem counter-intuitive at first glance, but it offers its own advantages. Rather than going against the trend, counter trend traders aim to enter the market at or near its reversal point. By doing so, they strive to set a stop-loss level very close to the peak or bottom of the reversal, while also defining their profit target using the relevant high and low levels of the previous trend. In most cases, counter trend traders are willing to sacrifice some probability of success in exchange for having clearly defined exit levels and a favorable risk-to-reward ratio. 

There is little justification, apart from psychological factors, to limit oneself to only one of these approaches. Even if you prefer counter trend trades, you can still take advantage of trading with the trend if you identify a well-defined stop-loss level. 

How do you trade Counter Trends in Forex？ 

Trading against the trend in forex includes taking positions that run counter to the market trend, which may be quite dangerous. But if done right, it can result in lucrative business transactions. You must take specific actions if you want to maximize rewards and minimize dangers when trading against trends. 

• Identify the trend: Identifying the market trend is crucial before trading. Technical indicators and chart patterns, like moving averages, trend lines, and support/resistance levels, can be used for trend analysis. Avoid trading against the identified trend. 

• Watch for reversal signals: When considering a counter trend trade, wait for potential reversal signals before entering the market. These can be found through technical analysis, like candlestick patterns, price action, and momentum indicators, or fundamental factors such as economic data releases, geopolitical events, and central bank policy changes. 

• Trade the Contrary Trend: Once you have confirmed a counter trend price movement, consider opening a position based on the general trend. If the overall trend is upward, anticipate a downward counter trend movement and take a short position accordingly. Conversely, if the overall trend is downward, expect an upward counter trend movement and open a long position. 

• Use appropriate risk management: Counter trend trading is high-risk, so manage risk effectively by setting stop-loss orders, taking profits at the right time, using appropriate position sizing, and never risking more than you can afford to lose.  

• Counter Trend Stop Loss: Always set a stop loss when counter trend trading. Place a stop order above top in bullish trend and below bottom in bearish trend, between trend impulse and expected counter trend move. 

• Be patient: Patience is key in counter trend trading as waiting for trend reversals and confirmation signals is crucial to avoid chasing the market. 

• Stay informed: Staying up to date on market news and events is vital when trading against trends. This helps you adjust your strategy to capitalize on changes in sentiment, and keep an eye on economic data releases, which can significantly affect currency pairs. 

• The counter trend trading strategy in forex can be challenging, but with careful analysis, proper risk management, and patience, it can be a profitable one. Although no trading strategy is foolproof, losses can still occur even with the best strategy. 

• When to Trade Counter Trends？ 

• Trading against trends is not similar to visiting a buffet and attempting to collect everything. Instead, you aim to take only a small bite and quickly exit the trade. 

• To begin with, it‘s advisable to stay away from highly unstable investments to minimize the chances of your stop loss getting triggered if your prediction about the counter trend’s timing is incorrect. 

• Next, it‘s best to avoid engaging in trades that go against the current trend during the first hour of trading since that’s when retail traders are more active in closing their positions. During this period, the price action is unpredictable and does not adhere to the expected patterns required for counter trend trades. 

• Lastly, its recommended to focus on trading during midday when trading volume is low, and technical analysis tends to be more effective compared to high volatility periods. 

• This is the approach to adopt when trading against trends in any market, including currencies and cryptocurrencies. The principle remains effective. 

• Popular Indicators For Counter Trend Trading Strategy 

• Here are some popular indicators used in counter trend trading strategies: 

• Moving Averages: In counter-trend trading, traders use moving averages to identify entry and exit points when the price of an asset has moved too far in one direction and is expected to reverse. For example, if the price is in an uptrend and has moved above the 50-day moving average, traders may look for a bearish candlestick pattern or a divergence in the RSI. They may then enter a short position with a stop loss above the recent high and exit the trade when the price approaches the 50-day moving average or a significant support level. 

• Relative Strength Index (RSI): Counter-trend trading with RSI involves identifying divergences between the RSI and the asset price to find potential trend reversals. Bullish divergence occurs when the asset price makes a lower low, but the RSI makes a higher low, indicating an upward reversal. Conversely, bearish divergence occurs when the asset price makes a higher high, but the RSI makes a lower high, indicating a downward reversal. 

• Fibonacci Retracements: Counter trend trading with Fibonacci retracements is a popular trading method that identifies potential turning points in a market using levels derived from the Fibonacci sequence. Traders identify a trend and look for potential reversal points at the 38.2%, 50%, and 61.8% retracement levels. Price action signals and technical indicators may be used to enter a counter trend trade while managing risk with stop-loss orders. 

• Bollinger Bands: Counter trend trading with Bollinger Bands involves trading against the prevailing trend when price reaches the upper or lower bands. To trade against the trend using Bollinger Bands, you can wait for the price to reach the upper or lower band and then look for a reversal signal, such as a candlestick pattern or an indicator divergence. Once you have identified a reversal signal, you can take a trade in the opposite direction of the prevailing trend. 

• Stochastic Oscillator: Counter trend trading with the Stochastic Oscillator identifies overbought and oversold market conditions and places trades against the trend. A bullish divergence occurs when the Stochastic Oscillator forms a higher low and the price forms a lower low. A bearish divergence occurs when the Stochastic Oscillator forms a lower high and the price forms a higher high. Traders can use these divergences as entry signals for counter trend trades. 

• MACD: Counter trend trading with MACD involves using the MACD indicator to identify potential market reversals and trade against the prevailing trend. A bullish divergence occurs when the MACD makes higher lows, and a bearish divergence occurs when the MACD makes lower highs. The trader can place a stop-loss order at the most recent swing high or low and set profit targets using support and resistance levels or a trailing stop based on the divergence. 

• Its worth noting that no indicator works perfectly all the time. Therefore, traders should use multiple indicators and analysis methods to confirm signals before taking a position. 

• 3 Reasons Why Countertrend Trading may not be for you!

• Regrettably, a significant number of traders try to identify the highest and lowest points in the market not based on fundamental or technical factors, but simply to experience the gratification of being correct. Although such attempts may offer favorable reward-to-risk ratios, its not advisable to seize every opportunity that arises. Consider the following three reasons before deciding to trade tops and bottoms: 

• There‘s usually no real top or bottom to what you’re looking at. 

• If you ask any experienced trader, theyll likely tell you that attempting to predict the highest or lowest point of a market trend is akin to trying to catch a falling knife or standing in the path of a fast-moving truck. In either case, the outcome is usually disastrous for your trading account. 

• This is because there is a significant possibility that the technical levels, youre considering may not be the same ones that other traders are focusing on. Additionally, other factors that are propelling the trend, such as market sentiment or fundamental economic indicators, may still be relevant even if you believe that the currency pair is approaching a top or bottom. 

• Poor risk management is caused by the subconscious need to be right. 

• Attempting to anticipate a market reversal can be a daunting task, particularly when you‘re aware that you’re going against the prevailing trend. Engaging in countertrend trading can also be challenging since its easier to misinterpret a temporary pullback on a long-term timeframe as a complete reversal on a shorter-term timeframe. 

• Furthermore, adopting the misguided belief that you can outsmart the market by accurately predicting its turning points can be detrimental. This mindset often leads traders to deviate from their trading strategies by setting overly restrictive stop-loss orders and failing to allow their profits to accumulate. 

• Trading Counter Trends Requires Experience 

• Despite the fact that both fundamental and technical analysis may indicate a potential market reversal, there is no foolproof method for predicting when or where exactly it will occur. That being said, if a trader does not leave enough room for reversals, their account may suffer long-term negative consequences. It is for this reason that seasoned traders advise against making predictions about market highs and lows.  

• Trading against the trend requires a comprehensive knowledge of the market, and even seasoned professionals recommend following the trend most of the time. Nonetheless, traders who prioritize proper risk management and allow sufficient flexibility to account for market fluctuations can select tops and bottoms with enough experience and preparation. 

• How to Learn Forex Trend Analysis？ 

• Are you looking to improve your trend analysis skills in the forex market？ Look no further than AximTrade‘s free forex online course. This course is designed with the beginner in mind, providing clear and concise lessons that will take you through the basics of trend analysis and beyond. You’ll learn how to identify trends in the forex market and use this knowledge to make more informed trading decisions. 

• What sets our course apart from others is our focus on practical application. We don‘t just teach you theory – we show you how to apply what you’ve learned in real-world situations. With our interactive exercises and quizzes, youll gain hands-on experience analyzing trends and making trades.

• And best of all, our course is completely free. Thats right – you can gain valuable knowledge and skills without spending a dime and start trading with the best broker! 

• Disclaimer: This post is from Aximdaily and it is considered a marketing publication and does not constitute investment advice or research. Its content represents the general views of our editors and does not consider individual readers personal circumstances, investment experience, or current financial situation.