Trend Trading vs Countertrend Trading

Trend traders go long when an asset is trending up. Higher lows and higher highs characterize an uptrend. Similarly, trend traders can enter a short position when an asset moves down. Lower lows and lower highs characterize a downtrend.

Trend trading strategies assume that an asset will continue to move in the same direction it’s moving in now. Such strategies often contain take-profit or stop-loss provisions to lock in profits or avoid large losses in the event of a trend reversal. Trend trading is used by short-, medium- and long-term traders.

Most traders can determine the current trend. The tricky part is to decide what to do about it. Let’s continue with the uptrend example. Trend trading implies that you will either buy at support or on the break of resistance. In the first case, you will use instruments like trendlines and Fibonacci retracements. In the second case, you can use continuation chart patterns like triangles, flags, and wedges.

Some traders will buy at point 1 (trendline support and Fibonacci retracement level), or Point 2 (a Flag pattern), and some will wait for Point 3 (a break above the previous high). Of course, the lower you buy, the bigger your profit can be.

Take-profit

You can set your profit target at the previous high of the uptrend (low of the downtrend) or even levels beyond it if you are more confident in your trade.

Stop-loss

Note that when you ride a trend, you can use a trailing stop that follows the trend. Be aware, however, that it may not be very easy to decide where to move a stop-loss. The risk is that a dipper correction can make the market hit your stop and close your order.

Scaling in

You’re allowed to add to a position when following a trend if the market has already moved in your favor and your trade has become profitable. That way, your potential profit increases. If you do this, don’t forget to adjust your risk management. You can also plan to start with a smaller trade than usual (for example, buy at point 1) and then increase it when the price gets above Point 2. This tactic will reduce your risk.

Countertrend trading

A countertrend trading strategy is an attempt to make a small profit by opening a trade against the main trend. Countertrend trading is a form of swing trading that assumes that the current market trend will experience reversals or pullbacks and then attempts to profit from those pullbacks as the underlying trend continues. This strategy is medium-term, where positions are held for a few days or weeks.

Some traders who use this strategy for profit use pullbacks while maintaining their main positions in the direction of the trend. Countertrend strategies use momentum indicators, support and resistance levels, and candlestick patterns to identify possible market entry points. However, traders using this method must be prepared to resume the current trend at any time without warning. Thus, when trading with this strategy, proper risk management techniques such as stop-loss orders and minimum position sizes should be used to limit losses.

Traders using this approach take hints from reversal candlestick patterns (pin bars, evening/morning stars, etc.). They also apply oscillators like MACD or RSI to see whether the market has become overbought/oversold and whether there’s a divergence between the price and the indicator. If these signs are present, traders open positions against the previous trend.

A trader may decide to sell at Point 1 as the price formed a candlestick with a long upper shadow (a negative sign) and the MACD indicator didn’t confirm the price’s high.

Take-profit

It’s harder to find a place to fix profit when you’re trading on a countertrend. The challenge is not to get too greedy. Remember that you’re betting against the market. Some trends can turn into a sideways market, limiting the profits from a countertrend position. The initial trend can also resume fast and not let the price correct too much. Be careful and manage your risk.

Stop-loss

The location for a stop-loss order in a trade like this is natural. Traders put their stop-losses behind the extreme point of the price, from which a correction has started. The stop-loss will likely be smaller than the one you would use if you were trading on the main trend.

Scaling in

It’s not a good idea to meddle with your position size when you trade on a countertrend. The trade can be very short-term, so you risk getting yourself in an uncomfortable position if you try to add to a trade. And never add to a losing position, as this is likely to lead to a bigger loss.

In our new video, we’ll discuss trend trading and countertrend trading more precisely.

Summary