Some among us are perpetual contrarians. When the market is going up, they think it should be heading down before long. When the market is going down, they think it should go up soon. However, for each transaction there must be a buyer and a seller, so one party is always a contrarian based on the prevailing trend. The question becomes whether or not it's possible to make money while always believing the market will reverse its course.
Tutorial: Technical Analysis

The short answer is yes, but it requires an understanding of three things: that opinion and action are two different things, that trends are where the money is and that price confirmation is needed for any reversal.

Opinion and Action Are Different Things
If you find that your natural tendency is to be a contrarian, you must realize that there can and should be a difference between opinion and action. If the market is rising and you feel it will eventually collapse, you don't need to act on that opinion right now. Opinion can be separated from what is currently going on โ€“ this will allow you to profit by trading with the market right now, instead of believing your opinion should be right at this time.

For more on indicators that contrarians monitor, check out Why is the disparity index indicator important to contrarian investors?

Opinion and emotion can wreak havoc on trading profitability, especially when traders develop very strong opinions or emotions. This is where it becomes imperative to design a trading plan before you start trading. This will allow you to act in a way that is aligned with your trading methods despite opinion or emotion. Trading on opinion can be very costly - the market can be "wrong" a lot longer than a trader can afford to be "right." A trader can design such a trading plan any way they wish, whether by trading with the trend, or watching for high probability reversal points. The key is that contrarians must not act only on opinion, but must take other factors such as actual price movement into account.

Trade With the Trend Even if You Don't Believe It
The development of trends is what allows the majority of traders to make money over time. A contrarian can trade in the direction of a trend, even if he or she feels it will reverse at some point. A trend will always reverse simply because prices do not move in one direction forever.

But just because a trader has an opinion about what the market will do, doesn't mean he or she has to act on it. Trading with the trend will allow the trader to capitalize on market moves while they are occurring instead of always waiting for a reversal. While markets do reverse, trends can last for a long time, even in the face of information that indicates otherwise. Since most individual traders can enter and exit the market with relative ease to due to their position sizes, trading against current price movements does not need to occur. (For more, see Keep It Simple โ€“ Trade With The Trend.)

An uptrend is defined as higher highs and higher lows, while a downtrend is defined as lower highs and lower lows. Therefore, all traders have a guide as to when trends are present. A trader can draw lines on a chart, called trendlines, along the price lows and price highs to give themselves a visual representation of the current trend. The current direction of the trend is where trades should be placed. When the trend actually appears to be in jeopardy based on price action, then the trader can begin looking for reversal trades that fit their contrarian view.

Trends occur on multiple time frames, therefore it is also important that a trader have a time frame for any given trade. For example, a one-minute time frame would not provide the relevant trend information for a long-term investor, just as a weekly chart is unlikely to help a day trader move in and out of positions. Analyzing multiple time frames can aid all traders in finding high-probability entry and exit points. For example, a pullback on a smaller time frame can often provide a valid entry for a longer term trend. (To learn more about this strategy, check out Multiple Time Frames Can Multiply Returns.)

Watch for Prices that Indicate Reversal
If the market is going lower and a trader feels it should go higher, he or she should trade with the trend. That said, a trader cannot get too attached to the trend, and must remain nimble and able to act when the trend appears to be reversing according to the his or her suspicions โ€“ and this turn is evidenced by actual price action.

Therefore, traders must trade in the direction of the trend if they wish to make money during that time frame, but if they feel that the trend could reverse they must have a price point that will tell them when this is actually occurring. One way to do this is to simply use the definition of a trend. For example, an uptrend is no longer an uptrend if it fails to make higher highs and/or makes a lower low on a pullback. It is possible that price may resume a higher path at some point, but a lower low is a valid signal that the uptrend is in jeopardy. This is when a trader who is looking for a contrarian reversal could step into the market. (To learn more, see Retracement Or Reversal: Know The Difference.)

In the case of a downtrend, a higher low or a higher high is a signal the downtrend is in jeopardy. There are many potential reversal signals that can be used, including trendline breaks, candlestick patterns, chart patterns or indicator levels. No matter what the method, it is best to wait for prices to confirm all reversal indicators and signals.

By watching for such reversal signals a trader can trade with the trend until it is in jeopardy; it is at that point that the contrary opinion is given credibility and the trader can act on that opinion.

Bottom Line
Traders can make money despite being perpetual contrarians, provided they control their opinions and realize that they do not need to act on them. Contrarians can also capitalize on the current trend by trading with it, and should only act on their contrarian opinions when the trend shows signs that it is in jeopardy. After all, if you try to buck the current trend, you could be left with an empty account, even if the market eventually takes the turn you predicted. (For more on contrarian trading, see Buy When There's Blood In The Streets.)

Related Articles
  1. Investing

    What Is Contrarian Investing?

    Learn the method and reasoning behind this contradictory investment strategy.
  2. Charts & Patterns

    How To Use Volume To Improve Your Trading

    The basic guidelines to analyzing volume may not apply in all situations, but overall, they can help direct entry and exit decisions.
  3. Mutual Funds & ETFs

    The 4 Best Lord Abbett Mutual Funds

    Discover the four best mutual funds administered and managed by Lord, Abbett & Co., LLC that offer investors a wide variety of investment strategies.
  4. Trading Strategies

    4 Common Active Trading Strategies

    Active trading entails buying and selling securities with the intent of profiting from short-term price movements.
  5. Mutual Funds & ETFs

    The 3 Best Vanguard Funds for Value Investors in 2016

    Find out which of Vanguard's value funds are the best for building a solid core-satellite value investing strategy for your portfolio.
  6. Investing Basics

    5 Questions First Time Investors Should Ask in 2016

    Learn five of the most important questions you need to ask if you are a new investor planning on starting an investment program in 2016.
  7. Mutual Funds & ETFs

    The 4 Best Fidelity Funds for Growth Investors in 2016

    Find out which of Fidelity's growth funds are the best funds for building a solid core satellite growth investing strategy for 2016.
  8. Mutual Funds & ETFs

    The 5 Best US Small Cap Value Index Mutual Funds

    Find out which index mutual funds do the best at investing in small-cap value stocks for higher potential returns at the lowest cost.
  9. Mutual Funds & ETFs

    The 5 Best T. Rowe Price Funds for the Income Seeker in 2016 (TROW)

    Find out which T. Rowe Price mutual funds to use to create a diversified income portfolio for current income, income growth and capital preservation.
  10. Investing Basics

    Building My Portfolio with BlackRock ETFs and Mutual Funds (ITOT, IXUS)

    Find out how to construct the ideal investment portfolio utilizing BlackRock's tools, resources and its popular low-cost exchange-traded funds (ETFs).
  1. Why is the disparity index indicator important to contrarian investors?

    The disparity index is a technical momentum indicator that compares market price to a time-defined moving average of market ... Read Full Answer >>
  2. What are common trading strategies used with the disparity index?

    Technical analysts and traders use the disparity index to spot abnormal or rapid movements in a security's price, showing ... Read Full Answer >>
  3. How do I use the disparity index in forex trading?

    The disparity index is a technical volatility oscillator that evaluates the relationship between current price action and ... Read Full Answer >>
  4. What is the disparity index formula and how is it calculated?

    Steve Nison introduced the disparity index in his book, "Beyond Candlesticks," as a way to analyze price movements in candlestick ... Read Full Answer >>
  5. What is Fibonacci retracement, and where do the ratios that are used come from?

    Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician ... Read Full Answer >>
  6. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
Hot Definitions
  1. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  2. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  3. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  4. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
  5. Godfather Offer

    An irrefutable takeover offer made to a target company by an acquiring company. Typically, the acquisition price's premium ...
Trading Center