What is Countertrend Trading
Countertrend trading is a type of swing trading strategy that assumes a current trading trend will reverse and attempts to profit from that reversal. Countertrend trading is generally a medium-term strategy in which positions are held between several days and several weeks. Countertrend traders rely on envelope channels (such as Bollinger Bands), indicators (such as the Aroon Indicator) and oscillators (such as the Relative Strength Index or Chande Momentum Oscillator) to make their decisions. Traders may use countertrend strategies for a variety of purposes including pure profit, diversification and risk management.
BREAKING DOWN Countertrend Trading
A countertrend trading strategy takes investment positions inverse to the current trend. This strategy can be used at any time but is often most commonly used when a trader sees strong potential for a reversal. Generally, countertrend trading may also be referred to as swing trading which refers to the opportunity to take advantage of a trend that reverses or swings in a new direction.
Countertrend Trading Strategies
Countertrend trading strategies are complex and therefore typically only used by advanced traders. They may be used for diversification and risk management or forward-looking predictions.
Diversification and Risk Management
Active traders are cautious about the percentage of their portfolio they risk on each trade with the 2% rule being a well-known practice across the industry. Advanced active traders trading according to technical signals will typically formulate grid trading strategies that place small trading bets trading into a trend at specified interval increases or decreases in order to manage their risk. Conceptually countertrend grid strategies taking inverse positions can also be a way for traders to manage risk.
Some contrarian active traders choose to fully focus on a countertrend trading strategy. These traders believe that by buying rather selling through a bearish downtrend or taking short positions rather than buying through an uptrend can potentially accumulate holdings that will profit over the longer term.
Another type of countertrend strategy most comparable to swing trading can be implemented when an investor seeks to take countertrend positions at resistance or support price points in the future. This type of strategy takes bets that the trend will swing to a new direction and positions trade orders accordingly.
A forward-looking countertrend strategy often requires the advanced use of conditional orders. Conditional orders allow an investor to specify a selling price near resistance levels or a buying price near support levels. Advanced conditional orders allow an investor to use a variety of both standard orders and option orders to specify a profitable price. Advanced conditional orders can also be programmed as bracketed orders which are executed when a reversal occurs and include upper and lower conditions to manage potential profit and loss.
For more on countertrend trading see also: Combining Trend and Countertrend Indicators.