The biggest challenge when using a countertrend approach to trading is working out in advance when the primary trend is about to turn. Read on to find out how both the optimum tools and correct mindset will enable you to make money more consistently with your countertrend trading strategy.
What is countertrend trading?
While with in-trend trading the profits come from capitalising on an asset’s price momentum in a given direction, countertrend trading is about profiting from predicting when a market is about to turn.
This active medium-term trading style pivots on finding positions where you think a market is overbought and the price is about to drop, or oversold and will recover sharply from its low, benefitting from the risk/reward ratios these setups present.
In-trend trading comprises two steps:
- looking for a trading principle,
- and then a confirmation.
Countertrend trading involves three steps:
- detecting the climactic action before the market turns,
- market rollover,
- and confirmation that it has indeed changed direction.
With countertrend trading, a trader can be in at the start of the move for a bigger and longer trade. So, let's take a deeper look...
Fundamentals of mastering a countertrend trading approach
Countertrend trading is not a style for the very beginner but would be the next step after a trader has got to grips with in-trend trading. As many experienced traders know, accurately predicting a real market top or bottom is an art that many lose too much money on trying to perfect, especially when smart money players deliberately make this difficult!
Part of this comes down to not being swayed by thinking errors and getting sucked into smart money propaganda spread through news reports that, for instance, the market is bullish and x, y and z companies had a good quarter, and then missing the top and being locked into a losing trade.
The second element to becoming a profitable countertrend trader is having trading tools that are sophisticated enough to detect a true market top or bottom. Lagging indicators are the nemesis of this countertrend trading.
The unenlightened traders use technical indicators along with fundamental analysis but, as we’ve explained in this recent blog on technical analysis, these approaches are limited in efficacy.
Some key rules when engaging in countertrend trading are to never place more than 2% of your total available capital on any one trade. You might want to reduce that percentage even more given that you might need to absorb some risk overnight or over the weekend.
How can you detect when the reversal is coming?
So, the big question is whether that’s a real market top or bottom before on the charts or just a retracement. The key is to look for bars with ultra-high volume, which Tradeguider calls ‘climactic action’ and Richard Wyckoff called ‘hypodermic price bars’.
Tradeguider’s software uses countertrend principles to alert you to the indicators that mark a major trend change or turning point on multiple timeframes.
Two important (or climatic) indicators that signal the top or the bottom of a market is imminent are:
- ‘The End of a Rising Market’ (a Sign of Weakness)
- ‘Bag Holding’ (a Sign of Strength)
When any of these important high-probability countertrend indicators appear on the chart, they are the footprints left by smart money players as they either accumulate or distribute to the herd.
When you see a Sign of Weakness, you need to check whether the next price bar closes lower than its predecessor. If it’s a Bag Holding indicator, then check that the next price bar closes higher.
Here are a few tips:
- Take care to check for low or very low volume bars at or near the same price level as those with the ultra-high volume, as this can mean the price direction is about to change quickly.
- Make sure you monitor weekly, daily and the 240- to 1-minute time frames but the bigger the timeframe in which the signal has occurred then the more likely a big move is to happen.
- Then it’s about placing your position according to your plan and strategy.
Learn more trend-trading secrets with Tradeguider
There is no point in entertaining this style of trading if your discipline isn’t solid with regards to mindset and risk management. If you think you have these key basics in place but you don’t want to work it all out for yourself, you can take advantage of our pre-set ‘TopBot’ countertrend trading strategy – it is one of four pre-set strategies that come with our SMART trader software.
The TopBot strategy identifies opportunities at the tops and bottoms of the market. It scans multiple markets for trend alignment in multiple time frames and then scans for the VSA principles that signal a potential change in market direction. See the Tradeguider team trade live using the TopBot strategy.
If a principle is detected it then analyses the market for the additional conditions we’ve identified as forming a confirmation signal. You then get an alert to the opportunity and can decide whether to take the trade or not. But just like any new approach try it out in a demo account first.
If you’d like to see some of these trend trading strategies in action, head over to the Tradeguider YouTube channel. You’ll see we have an array of recordings of live trading sessions to give you a clearer idea of how Wyckoff VSA can change your countertrend trading approach from stabbing in the dark to making informed, data-supported decisions.
Tradeguider is the home of Wyckoff Volume Spread Analysis (VSA) - the proven methodology that helps even the most seasoned of traders boost their profitability. Are you a professional trader who wants to improve consistency, structure and efficiency? Maybe you’ve heard of volume analysis but stick to the technical analysis approaches you know? Get in touch with the Tradeguider team or book a demo to learn more about countertrend trading and our rules-based strategies.