The Pros and Cons of Countertrend Trading

Have you ever wondered about trend trading and countertrend trading, and which is better or worse?  Here are some of the pros and cons of trading against an established trend.

Pros:

Make money in both directions

One of the benefits that makes countertrend trend trading attractive to people is that you can potentially make money going both ways.  For example, if you are trading with an ongoing trend there will always be major pullbacks on the higher timeframes where you potentially have the opportunity to take profit on the current trending position and look to trade the pullback as a countertrend move. As you can see below, the S&P 500 index is a good example of this on the weekly timeframe.  On many occasions over the past two years there have been countertrend moves for several weeks that are tradable on the lower timeframes.

(The S&P 500 weekly chart below illustrates countertrend moves that last for several weeks that are tradable on lower timeframes)

Looking for major pullbacks

When I say major pullbacks, what I am talking about are the pullbacks on the higher timeframes such as the weekly and daily timeframes.  You will notice that in every strong trending market, price will get over extended from the moving averages and then it will pull back into the moving averages for the next move in the direction of the trend.  So for example, the weekly timeframe may take several weeks for that pull back to occur … and that pullback will then form a trend on the lower time frames that actually is tradable.  In essence, even trading countertrend is a form of trend trading – you just need to remain aware of what the higher time frame charts are doing.

Getting in at the beginning of a new trend

Another form of countertrend trading is looking for the reversal point of an ongoing trend.  If you can get it right … you are potentially in at the beginning of a new trend.  In such cases the reward:risk can be very high and so you may be stopped out on several attempts but the reversal move you are looking for could turn out to be a good runner.  It is important to note that countertrend trading is a lower probability trade setup than trading with the ongoing trend.

Cons:

It can lead to picking tops and bottoms

The downside to countertrend trading is that it can lead to constantly picking tops and bottoms in the market, which tends to be a losing proposition.  In a strong trend it takes a while for traders and investors to stop trading with the trend and the development of the reversal or the pullback can take some time to occur.  This simply means that you are waiting around to go against the trend when you could just as well be trading with the trend.

Scalping countertrend can be frustrating

Even as you are trading with an ongoing trend, some folks like to scalp some countertrend moves as well. You will find that these countertrend scalps are not as rewarding as the trade setups going with the predominant trend.  If you are going to risk your trading capital it makes sense to risk it for a substantial reward.  Scalping against the trend feels like you are swimming upstream.  The risk of getting stopped out is much higher and you will find that the price action will bounce in the direction of the trend more often than not.  This can be very frustrating over time when stops are getting hit, or when you are into some profit on a trade just to see it evaporate and stop you out.

Moves against the trend are short-lived

If you take a look at any strong trending chart you will notice that the countertrend moves are much smaller than the moves going with the trend.  It works like this … if the market is in an uptrend than it is typically taking two steps forward and one step back in order to form the higher-highs and higher-lows that determine the uptrend.  So in essence you have twice the profit potential or more going with the trend than you do going against the trend.

In most instances it is better to trade a trend from a single direction going with the major flow of money into or out of a particular market.  Going with the momentum or taking the path of least resistance creates a higher probability trading scenario and is much more rewarding.  Psychologically this keeps the trader in a positive mindset when working a trend from a single direction.  And the countertrend pullbacks are just another opportunity to trade in the direction of the ongoing trend.

By Toby Genaro

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