Pull a rubber band and it will stretch, change colour as the rubber starts to break and this is the warning, that if you pull a bit further, it will snap back and break. This very often happens in Forex markets and this contrary trading strategy, aims to take advantage of this concept. In the market you can see what I would call a change of colour, before the snap back. This is your chance to put on a contrary trade and execute your trading signal, against the majority of traders and make a quick profit with low risk.
Of course, market timing is the key with this trading strategy but with a few technical tools, to help you, get in when the odds of a turn are at there best and the risk to reward, heavily favours a price break which is contrary to the existing trend in the currency pair you are looking at.
Contrary Trading Explained
The majority of Forex traders always tend to be very bullish at market tops and bearish at market bottoms, before the trend changes. This doesn't just apply to retail traders, it applies to large investment houses and banks as well. These traders are driven by greed or fear and think, the trend will never end but all big trends end and when they do they end – they end with little or no change in the fundamentals or news. So why does this happen?
The reason is simple – the price has been pushed to far up or down, to many speculators have gone long or short and there is no buying or selling power left, to drive the trend on so the market snaps back. Stops are hit and the trend ends in dramatic fashion. In really big trends, not only are stops hit but new trading signals are triggered and turn the correction into a new trend.
Simple Contrary Trading Strategy to Spot High Odds Trend Changes.
To spot high odds trend changes, simply get out a chart and look for a currency to dramatically increase in price in a short period of time. You will see the price move quickly away from the mean price ( we like to use a 40 day Moving average as a mean price) and the price rise, will rise dramatically from this average when greed or fear, take hold of the market participants.
At the same time, you will see so called experts on the news wires and broker reports, saying this trend is going to continue and there is nothing they can see to end it. Now you don't have to look at the news but if you see stories like this, you know that the trend will end but you can just use the charts if you wish. So what indicators should you use? You can use any of the popular momentum indicators but for the purposes of illustrating, how simple this trading strategy is we will use just one trading indicator the stochastic.
A Stochastic Trading Strategy – and the Snap Back
In our example, we are going to show you how to use this strategy in terms of a currency pair which has moved to far to the upside. Most people use the stochastic and consider it overbought at 70 and oversold at 30, others use a setting of 80 – 20 but for this strategy, we want to use a setting of 90:10. In terms of a up move, when the stochastic reaches 90 (on the fast line) then its time to look for a trading signal against the trend. In terms of the slow line, the closer it is to the fast line the better and normally, we look for a reading above 80. The shape of the stochastic lines is also important in terms of how steep the rise is - the steeper the move up, the better the trading signal is in our view.
Once we have the set up and the fast line above 90, it's time to watch for a stalling of momentum and as soon as the lines stall, its time to enter a trading signal. Note that here were not waiting for a cross to the downside, we will go with the stalling of the lines and get in early. As soon as the trading signal is put in the market, we need to set a stop and this needs to be not behind the first obvious level of resistance but behind the second level of resistance in case there is one more push up. We then wait, looking for a move back to at least the 20 day MA and we normally, expect the 40 day MA to be tested.
Why the Strategy Works
Even in a big bull trend prices will normally pull back to at least the 20 day MA and this is a good level to target to take profit but watch the price as it comes into this level and decide if momentum can target the 40 day MA. You will have varying risk taken to reward and we find our normal risk to reward is between 2:1 - 3:1 which seems quite low but the odds of the snap back are high, so the odds of trading this set up are very good.
The stochastic is not the only indicator, you can use to do this strategy - there are many more but the stochastic is easy to understand and is a great visual indicator which is easy to learn and works well.
Patience – the Key to Making this Strategy Profitable
The key to this strategy is patience! you will not get these set ups very often but when you do, they offer fantastic risk to reward trades. The logic is simple to understand and based the fact that in any financial markets, a sharp move from the mean price and increased volatility is normally short lived and reflection of greed or fear of the majority of traders.
This is a simple strategy which simply works on the assumption that price spikes away from the mean or average price don't last long and by selling into greed and buying into fear at the right time, you can make fantastic profits with low risk. Is this a simple currency trading strategy?
Yes it is and its easy to learn and apply and even better news is – if you make it part of your essential Forex trading education, you will have a strategy which works. This form of trading will always work and will help you trade contrary to the majority of traders, who always push prices to far to the upside when greed is present and to far to the downside when fear is present. Learn this simple strategy and it can help you enjoy long term currency trading success.