It’s very easy to lose money when trading anything. Just one mistake, one little error, could send all your hard work, effort, and potential earnings down the drain. However, one of the most common and easiest ways to do so is to trade against the trend.
In this article, we’ll tell you all about trading against the trend and why you shouldn’t do it.
What is a ‘trend’?
The trend is simply just the direction that a certain asset’s price is going–whether it is going up, which means it’s gaining value, or going down, which means it’s gaining value. In technical analysis, trends are identified by ‘trendlines’, which are lines that indicate uptrends and downtrends.
Uptrends are indicated by rising price points, which means that there are higher-top peaks, also known as swing highs. There are also higher low peaks or swing lows. Downtrends are characterized by lower price points, which means that there are lower swing highs and even lower swing lows.
The trading world is divided on how to treat these trends. Some traders, called trend traders, prefer to trade in the same direction as the trend, which means buying when prices are rising, and selling when the prices are falling. However, some seek to identify reversals and bet against the direction of the market.
As mentioned above, in this article, we will discuss reinforce the adage and discuss why you should always follow the trend–and how to recognize when you shouldn’t.
How trading against the trend loses you money
Let’s consider an example. You’re trading the EUR/USD currency pair, and for several hours the trend has been gradually going up and then ranging. Suddenly, an interest rate increase in the US is announced. The result is a sudden drop in prices.
The prices sink and sink like a rock thrown into deep water–but hoping that the earlier bullish trend continues, you place a buy order. However, it loses. Prices continue to drop. So you place another buy order hoping to regain your lost money, but the prices continue to drop. You continue placing losing orders until, finally, your account is depleted.
And then the price goes back up.
Trend followers always preach that no one ever knows when the trend will reverse, so why try to trade against the signs of the market?
When should you religiously follow the trend?
Take note of the EUR/USD chart below on the Binomo trading platform. There is a steady increase in prices starting from 13:00 on the 13th of June. This upwards momentum continued for 24 hours before a sudden break resulted in a severe drop in prices.
This long drop occurred for 2 hours before the bearish candles shortened and started to stabilize. For the majority of the traders, this could have been the signal of a trend reversal and so they would have likely placed buy orders.
But prices continued to sink. If you observe the prices falling sharply and breaking levels after levels of support and resistance, then it’s very likely that the price will continue to fall. When this happens, it’s recommended to simply go with the trend and place a sell order.
The data doesn’t lie. When you trade against the trend, you are much more likely to lose.
Sure, after some time the trends will reverse and the prices will eventually form new resistance and support levels. Often at this point, the price hits a certain point before bouncing back and thus creates strong resistance and support levels. If the price breaks these new levels, it’s time to trade with the trend again.
When the trend might make you lose money
In the Binomo EUR/USD chart below, you’ll observe that prices tend to fall to a certain level before bouncing back up. This level which seems to prevent the prices from pointing downwards is called ‘support’ because it supports the price from falling. There are small trends present in the chart but they’re not useful unless you’re trading in short time frames.
Here, when the prices are above the support level, it’s best to sit back and let the buyers and sellers fight it out. But once the support is broken by a large, sudden drop in prices–signified here as a large bearish candle–it’s a sure indication that a downtrend has developed.
This means only one thing: it’s time to enter a sell position.
Trading with the trend is hard when prices are ranging, so sit back and let the buyers and sellers fight it out.
Overall, the trend is your friend
To wrap it all up, the lessons in this article are actually pretty simple. Try to avoid trading against the trend. In fact, if you notice a trend forming, it’s actually best to just trade along with it.
That said, it’s not all the time that you should trade along with the trend. Sometimes, and I really mean sometimes, there are times that you should trade against it, such as when the trend hits the support and resistance levels. Do keep in mind that you must tread very carefully when betting against a trend, as no one ever knows when it is going to revenge or range. Only the markets can tell, and the best you can do is ride the waves
Do you ride the trends? What techniques do you utilize to identify a trend besides the break in support and resistance levels? Share them in the comments section below! And if you haven’t yet, sign up for a free demo account on Binomo to start trading today!
Good luck on your trading journey with Binomo!