The biggest profits tend to be made when a trend changes and a new trend develops At these turning points risk is low and profit potential is high. The uninformed trader is always caught long at important market tops or short at market bottoms. If you learn to trade contrary to the majority at these turning points you can enjoy spectacular trading success but how do you do it? Lets find out.

The Logic Of Contrary Trading

The logic is simple – any market is made up of a huge number of traders who all have the same facts to look at in terms of price but all draw different conclusions from what they see and they do so influenced by the emotions of greed and fear. When greed takes hold, prices over shoot to far ahead of the fundamentals on the upside and the same happens in reverse in a bear market.

Eventually, the markets are discounting all the good or bad news and a huge number of traders are long or short. There is no other news to push the market higher or lower. What happens next is a few smart traders start to trade contrary to the crowd and then, stops start to get hit and a scramble starts as traders start to exit the market. In a bull market the price starts to fall, as smart traders help to form the top by selling, next the weak longs are hit on stop which causes more selling and then greed turns to fear and another huge wave of selling occurs as more traders exit the market.

Market Timing at Tops and Bottoms

We all know price surges on greed and fear will end but the key is to time to move when the risk reward is at its best. The first thing you need to do is look for a market which is over bought or oversold and this is quite easy.

• Read the news and look for a consensus of the move last for ever, no end in site and heavy coverage in the media.

   

• Check % Bullish or other polls of people which indicate overbought oversold. If under 20% are bullish a move up is expected if over 80% of people polled are bullish a move down is expected.

   

• Check the CFTC Net traders positions and look for speculators both large and small to hold extreme net short or long positions which are opposed by the commercial traders. The commercial traders are hedging and not motivated by greed and fear (unlike the speculators) and if they are heavily net long a market, its fair value and if their heavily net short a market, its over valued. You can read more on this valuable tool in other articles on the site.

Once you have established that a market top or bottom maybe forming, you need to look for shifts in momentum contrary to the trend and look to time your trading signal.

Here are some indicators, you can combine to help you do this and there all described in great detail elsewhere in the site.

• The Stochastic: Look for turn ups or turn downs from extremes with bullish or bearish divergence.

   

• The Relative Strength Index: You do the same as with the stochastic.

   

• The Average Direction Movement: An excellent way to use this line in a strong trend is to look for a turn down of the ADX from above 40.

   

• MACD: This indicator is more lagging than the stochastic and RSI but trading divergence here can also help you confirm the top.

Always look for support or resistance to hold and momentum to turn down, before executing your trading signal or if you want to go early, then use options to help you ride out an overshoot against you.

Using Options for Top and Bottom Picking

Currency options are a useful tool in terms of top and bottom picking because, they give you staying power and you don't have to worry about short term price spikes against you. All you need to do is have your option trade in the money by the time it expires and you make money.

The key with using options is to always buy at or in the money options and get time on your side. If you remember these two tips, you can get staying power and ride out any short term overshoot in price.

The More Uncomfortable You Feel the Better!

If you feel uncomfortable doing a trade, don't worry! It's likely to be a good one. When a big bull or bear move ends, there will be nothing to indicate from most other traders behaviour and the news will give no clues. The key to being a good contrary trader is to take a stand against the crowd at the right time and providing you have solid reasons from the above indicators for doing so, have the courage of your conviction and take the trade.

Final Words

Sure trend following can make you a lot of money and most of the time you should focus on locking into and holding trends - but you should always be on the lookout for contrary trading opportunities and benefit from the low risk and huge profits these market turning points can give you.

If you want to make big profits with low risk, include contrary trading in your currency trading strategy and you will make far bigger profits from your Forex trading signals.