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What It Takes to Succeed as a Countertrend Trader

Jay Kaeppel
2021-08-09
The old adage states that "The trend is your friend." But not everyone plays that game. Some seek to maximize profitability by playing the inevitable reversals. And those who succeed perform exceptionally well. But it takes a certain mindset to do so. Read this short piece to see if you have what it takes.

Picture the following:

  • A bad - but premature - breakup
  • Think of what went into building that relationship and all the promise it held at the outset
  • Then ponder the attendant anger, frustration, bitterness, and recriminations leading up to and immediately following the breakup
  • Now imagine that very shortly thereafter, you realize that you didn't need to split up in the first place

Congratulations, you now understand the gist of countertrend trading.

THE PROPER PERSPECTIVE

For the record, an alternative title for this piece might well have been "Placing Speculative Bets Against Everyone Else." But - truth be told - I was afraid no one would read it ("Into the Buzzsaw" was another possibility, but I digress).

The real gist of this piece is to acknowledge that while trading with the trend (in my opinion - and that of many others) purportedly offers traders a higher probability of success (at least in theory), the reality is that:

  • Countertrend trading IS a viable approach to trading
  • But ONLY for those who have the proper attitude and mental framework

This leads me to invoke the following:

Jay's Trading Maxim #17: Countertrend trading is perfectly viable - as long as you are willing to be wrong. And then wrong again. Oh, and possibly again, before finally (maybe) being right - assuming, of course, that you are still taking the trades (HINT: It is doable but can be even harder than it sounds).

The bottom line: You want to take a shot, take a shot. But, to achieve any real long-term success, you must:

  • Be realistic about your expectations
  • Understand that you may have to stop yourself out and later re-enter (possibly several times) before getting the payoff you expect (NOTE: The majority of individuals are not "wired" this way.  So be careful about assuming that you are one of them)

THE GREATEST DANGER(S)

The greatest danger in counter-trend trading is that you enter a position against the prevailing trend and DO NOT have any stop-loss provision or plan in place.  The current trend then accelerates, and you find yourself with a massive open loss.

However, as long as you use stop-loss orders to limit your financial risk on each trade, the greatest danger of countertrend trading is psychological.

Do not underestimate the following two points:

  • Countertrend trades can be stopped out within mere moments of being entered
  • Mustering the courage and fortitude to jump right back in when countertrend conditions reset is what separates the winners from the losers

HOW TO ASSESS YOUR OWN LIKELIHOOD OF SUCCESS

To figure out the likelihood of your own success using this approach, ask yourself these questions:

  • Do you feel like a "winner" after a winning trade and like a "loser" after a losing trade?
  • Do you invest not only your money but also your ego when you trade?

If you answered "Yes" to either of the questions above, then countertrend trading is NOT for you. 

To spell it out, if you are an emotional trader, the most likely scenario for your journey into countertrend trading goes something like this:

  • You do whatever level of analysis is required to prompt you to enter a countertrend trade
  • You take the plunge - certain that you are about to nail the top (or bottom)
  • The market laughs directly in your face and blows through your stop (please, please tell me you used one!) very quickly
  • You are stopped out with a loss, and you spend the next several days/weeks/months kicking yourself for being such a fool and wondering, "what was I thinking about"
  • During this period of "kicking and wondering", the market actually does put in the top or bottom you were anticipating
  • Unfortunately, because you are too busy kicking yourself, you fail to muster the gumption to get back in

If all of this sounds a little too harsh and pessimistic, all I can say is, "I don't make the rules."

IN SUM

To summarize, countertrend trading can ONLY be of value to those individuals who:

  • Eschew any emotional attachment to each given trade AND;
  • Are capable of jumping back into the fray quickly if need be.

The bottom line:

  • Countertrend trading can be extremely lucrative
  • But success requires skills (and a type of personality) that not everyone possesses

You have been warned.

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