What is a reverse trend strategy?
The reverse trend strategy seeks to make a small profit by trading against the current broader trend. Traders also call this practice reverse trend trading.
This is a form of swing trading that assumes that the general trend is reversed and that it seeks to profit from it as the trend continues. Reverse trend trading is generally a medium-term strategy, where positions are held for days or weeks.
- The reverse trend strategy makes a profit with the goal of temporarily adjusting the price behavior of the trending securities.
- This strategy involves buying and selling securities that have experienced impulsive bearish / bullish movements. It expects that the upward / downward movement of the corrective movement will allow it to sell / buy back at its high / low price.
- The reverse trend strategy uses momentum indicators, reversal patterns, and trading ranges to determine the best area to execute a trade.
Understand the reverse trend strategy
The reverse trend strategy targets the modification of the price behavior of trending securities to make money. Contrarian traders often develop reverse trend trading strategies. This strategy involves buying and selling securities that have experienced impulsive bearish / bullish movements. It expects that the upward / downward movement of the corrective movement will allow it to sell / buy back at its high / low price. In both cases, the low buy and sell paradigm is met and the trader’s account becomes the beneficiary.
Traders using this strategy will realize smaller profits and are ready to stop if the expected corrections do not appear. The reverse trend strategy ignores the general investment philosophy that trends are your friends, at least for the time being.
The reverse trend strategy uses momentum indicators, reversal patterns, and trading ranges to determine the best area to execute a trade. Traders using this strategy should always keep in mind that securities can resume trends at any time. Therefore, risk management techniques such as stop-loss orders should be used to limit possible losses.
Building a reverse trend strategy
Traders can use momentum indicators such as the Relative Strength Index (RSI) in combination with price support and resistance areas to find high probability turning points. For example, a reverse-trend trader may buy securities if he finds support at a 52-week low and the RSI shows an oversold reading of less than 30. Conversely, if the price of a security reaches the resistance area and RSI, the trader can open a short position. Move over 70.
To add further confirmation, traders may wait for a bullish or bearish candlestick pattern before entering into a trade. The range of the reverse trend should be wide enough to have a profit target of at least twice the stop loss. For example, if a trader is using a $ 5 stop loss, the profit target should be at least $ 10.
Benefits of using a reverse trend strategy
More trading opportunities
If the price of a security fluctuates within the trading range, it offers many opportunities to buy with support and short-sell at the resistance. The investor may have to stay in his hands for a long time if he only trades pullbacks in the trend market.
Reverse trend strategies usually have a shallower drawdown than trend-following strategies, as traders make smaller profits on a more regular basis. Trend strategies can generate more substantial profits as a whole, but traders can stop many times before catching a big move.
Restrictions on the use of reverse trend strategies
Acting on the basis of more trading opportunities will pay more fees. Traders who use a reverse trend strategy and are expected to trade a lot each month should consider using a per-share fee structure. This means that the broker will charge a flat rate per share, not a per-transaction fee. After that, the trader only pays the commission for the number of shares traded. This allows you to expand and contract your position more spartanly.
The reverse trend movement does not last as long as the trend movement. Therefore, traders need to frequently monitor the market to find the best entrances and exits for trading. Traders can automate reverse trend strategies to overcome this limitation.