The "reverse operation" in trading, as the text suggests, refers to establishing a position that is opposite to the current market sentiment or trend. Simply put, it is: trading against the trend. This trading strategy is usually used when the market reaches a certain level, and the trend will reverse.
For some untrained novice traders, the strategy of trading against the trend may sound a bit surprising, because generally we believe that trading should be done with the trend, and trading against the trend is a taboo. However, the case of the famous trader Jesse Livermore tells us that contrarian trading is the most effective and profitable trading strategy as long as it is used properly.
The use of contrarian trading strategies requires traders to have a high degree of discipline and solid market analysis skills. In addition, traders also need to reserve a part of funds to prevent the market from immediately reversing. In many cases, orders for contrarian trading often do not It will make a profit immediately, and the market will not make a profit immediately.
The vast majority of traders will advocate trading with the trend. They strive to find and grasp the market trend, and the direction of opening positions is consistent with the current market trend, but some traders will choose to trade against the trend.
The contrarian trading theory mainly involves the monitoring of market sentiment and other important indicators to determine the direction of the transaction. This theory advocates that the direction of opening positions should be opposite to that of most market participants. For example: when the market is in a highly pessimistic (panic) mood, the price will fall to an extremely low level and much lower than its intrinsic value. At this time, a long position should be established. Conversely, when the market is in a highly optimistic (greedy) mood, the price will rise to extremely high levels, far above its intrinsic value, at which point short positions should be established.
There is always an end to ups and downs, and there is always a time when the trend reverses. However, before the trend reverses, people are willing to believe that the trend will continue, so they will trade with the trend. No one can predict the top and bottom of the market. Most people prefer to Go with the flow, and don't want to risk going against it.
Trading against the trend not only requires extraordinary courage and rigorous analysis, but also always be alert to the existence of risks. Traders against the trend usually set up stop losses to control the loss of their orders. If the trend does not reverse, but continues, then Traders will not cause large losses. The stop loss position of contrarian trading is often set a little above or below the key support level or resistance level. The reason why there is a certain space is that when the price touches the key support level or resistance level, it will cause short-covering or short-selling. Longs cover, causing the price to reverse.
The basic principle of contrarian trading is that when the market is extremely bullish, the price is likely to have reached the top; when the market is extremely bearish, the price is likely to have reached the bottom. Therefore, by judging the sentiment of market participants, we can know whether the market is at the top or bottom, so as to build positions against the trend.
Most retail investors in the market lose money. The reason is that they buy when the market is close to the top and sell when the market is close to the bottom. This is rooted in the deep-rooted "trading with the trend" thinking of retail investors. People often continue to buy when they are overbought, and continue to sell when they are oversold. This kind of public awareness has caused many retail investors to become "leeks" and let the big dealers slaughter them. Trading against the trend is to allow traders to keep a clear mind, not follow blindly, have their own clear and objective judgment, and not be brainwashed by market emotions, so as to make correct trading decisions.
Group psychology directly affects group behavior, and group behavior determines market trends. No matter what type of investment, stocks, bonds, funds, foreign exchange, etc., as long as it is an investment type that is publicly traded in the market, its price must be affected by group behavior. .
The market is composed of buyers and sellers. Only when there are buyers and sellers can a transaction be concluded. In this case, the most direct factor affecting the price is the buyer and the seller (or the relationship between supply and demand). The change in the power of buyers and sellers determines the price trend. When sellers are stronger, prices will rise, and when sellers are stronger than buyers, prices will fall. This is the most basic principle in economics. The price of any commodity or asset (such as stocks, foreign exchange, gold, etc.) used for trading is determined by the relationship between supply and demand.
Market participants are collectively referred to as a group, which is divided into: buyers and sellers. The behavior of the buyer group and the seller group directly determines the price trend. The main driver of crowd behavior is crowd psychology, so monitoring crowd psychology is critical.
Contrarian trading requires traders to use fundamental and technical methods to comprehensively judge whether the market will reverse. Among them, monitoring group psychology is a fundamental analysis method, which helps traders judge whether the market is currently in a state of extreme pessimism (panic) or extreme optimism (greed).
There are many ways to monitor group psychology, such as paying attention to some indexes, CBOE VIX index, CNN’s fear and greed index, etc.; you can also pay attention to some news information in the market, whether the market is overwhelmingly negative news or positive news; in addition, There are also the views of people around you, such as the views of friends and family on the financial market. There are other ways. In short, as a trader, you must always pay attention to changes in market sentiment.
In addition, fundamental economic data and central bank policies also need attention. These information can reflect whether the current market price is overvalued or undervalued, and whether the current price is in line with its intrinsic value. The price will always return to the equilibrium value, and it is impossible to deviate from it all the time. There are also some data reports, such as the COT position report, which are also worthy of attention.
In addition to fundamental analysis, contrarian trading also needs to be combined with technical analysis. For example, you can use some technical indicators, such as RSI, Oscillators, or directly through the price chart to judge whether the market has reached the top or bottom, and the upward momentum of the market. Or whether the downward momentum has exhausted, and whether there will be a reversal.
For example, in the EUR/USD daily chart below, the RSI indicator, Oscillators oscillator indicator and MACD indicator are used. These indicators can measure the volatility of the market and the degree of overbought or oversold.
In addition to the indicators mentioned above, the Elliott Wave Theory is also a technical analysis method. The theory states that the market advances in waves, with five rising waves and three falling waves. When the market reaches the fifth wave At the top, the market will reverse.
When trading against the trend, the time frame observed by the trader will affect the application of the analysis method. For example, if the trader focuses on the 1-hour chart or a chart with a smaller period, then directly use some technical indicators, such as RSI, etc. ; but if you are concerned about large-cycle charts such as daily and weekly charts, you should pay attention to position reports, economic data, etc.
In short, before trading against the trend, you must do a full market analysis to verify that the more information that the market is about to reverse, the better. The more evidence, the greater your confidence in trading against the trend, and the more confident you are when placing an order.
Taking stock trading as an example, contrarian traders need to conduct in-depth analysis of the market. When retail investors in the market are in the frenzy of buying or selling, contrarian traders will carefully study the corresponding stocks. Look at the financial statements of listed companies to see if the financial information can support the existing stock price rise. If the current financial situation is not satisfactory, but the stock price continues to soar, the market is full of news about the bull market, people are enthusiastically investing in the stock market, and the media continues to follow suit, then you need to be vigilant. It may have been overly optimistic, and the reversal is likely to come. This is also the time for contrarian traders to short in the opposite direction.
During the US subprime mortgage crisis in 2007, hedge fund manager Michael Burry used credit default swaps (Credit Default Swaps) to short mortgage securities that were on the verge of danger. Michael Burry conducted an accurate valuation analysis on the market at that time , and seized the short-selling opportunity of mortgage securities. With the rise of adjustable mortgage interest rates and the collapse of real estate prices from historical highs, a wave of subprime loan defaults set off, and the market turned from extreme optimism to pessimism. Asset prices of mortgage securities plummeted. But Michael Burry made a lot of money, bringing huge returns to his fund company clients.
In addition, the concept of contrarian trading comes from the cyclical operation of the market. It is precisely by grasping this rule that contrarian traders can go against the trend and seize the opportunity to enter the market before the market reverses.
Create a contrarian trading plan
The use of any trading strategy must be coordinated with the trading plan, and the same is true for contrarian trading. A contrarian trading plan must be rigorous, list analysis factors, observe indicators or information, under what circumstances to open a position, under what circumstances to close a position, how to set a stop loss, and the profit target. . . etc. The trading plan should be concise and clear, with prominent points and executable.
Compared with the general trading plan, the most important point of the contrarian trading plan is the problem of stop loss, because the risk of contrarian trading is very high. If the stop loss is not set, once the market trend continues to advance, the loss will be infinitely enlarged, and eventually It is likely to face the ending of liquidation.
Finally, I would like to mention that trading against the trend requires a lot of psychological courage and perseverance, and requires a high level of analysis and decision-making on the traders themselves. The reason why ordinary traders dare not trade against the trend is largely due to These two reasons.
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