What You Should Know About Trading Contra-Trend Moves

The S&P put in a classic intraday head and shoulders on the 30- and 60-minute
charts on Friday, while the Nasdaq could only muster an Igor-type shoulder
formation as it quickly lost hourly support in the morning session. Both markets
then followed through nicely from screaming price vs. momentum divergences in
the afternoon plunge upon the loss of respective supports.

As was the case last Monday, short trade premises on the 13 and 60 will once
again be in force when the market opens next week, assuming no news or extreme
gaps. And while the daily support provided effective resistance on the short
trades earlier this week in a textbook 60 vs. daily fashion, the daily pattern
suggests a break could lead us back toward weekly trend supports, which we
haven’t seen in some markets for almost a month.

Moving Avg
Legend: 15MA
Larger Timeframe 15MA

See https://www.donmillertrading.com
for Setups and Methodologies

Charts © 2003 Tradestation

Let’s first discuss what I mean by contra-trend, which I would define for our
purposes as a situation where a trade is made against the prevailing intraday
trend supports based on waning momentum, a stretched price condition (from a
moving average), or similar premise. I don’t mean fading moves on
lesser timeframes when the larger 13- or 60-minute trends support your trade and
you’re effectively trading a pullback with the trend on a larger
timeframe, although waiting for a one-minute turn is usually beneficial. Yet
rather than discussing one of the more obvious reasons for not creating a
trading business plan using such techniques — including not having the darn
wind at your back — I’d rather focus on the lesser-known area of how it can
adversely impact one’s focus.

First, can such trades work? Absolutely. Do technical indicators help define
such opportunities? Yes. Do I take them from time to time? You bet. But here’s
the difference: Should such trades reflect the cornerstone of one’s plan?
Absolutely not. Why? Lots of reasons. First, the profit potential is limited as
exits should occur on the retrace to trend support (resistance on the trade). Many
traders often take such entries inappropriate as an “early” reversal trade
rather than a contra-trend trade with a clear exit at trend support, but that’s
another story. Second, stop setting becomes difficult given the more poorly
defined momentum indicators (vs. a trend support indicator such as a moving
average). And then there’s the wind at your back issue when has been discussed
by many for decades. There are other reasons, but we’ll leave it at that for
now.

Yet actually the main reason I recommend against taking them, is that taking
them can condition your mind to look for them rather than searching for
the more meaty — or perhaps better said: higher probability — trend
entries or whatever type of entry constitutes your bread and butter trading
setup. For even if such a trading technique only reflects a small portion of
one’s trading arsenal, the challenge becomes one of focus.

What I mean is that focusing on contra-trend retracement trades often results in
traders continually looking for divergences and trend turns, rather than
focusing on the trades that reflect the bulk of one’s plan. And I’ve found this
true time and time gain, even with traders who say they primarily trade with
the trend! It’s frankly often how many slumps are born. Yet all that is
often required is a change in focus, perhaps by swearing off such trades for a
period of time.

For example, I’m currently working closely with a trader who has turned his
thinking around from pursuing primarily contra-trend trades so he’s now more on
the alert for 5MA/15MA crosses and first pullbacks. Result? He’s on a six-day
winning streak with one negative trade. And while contra-trend trades remain an
effective part of his arsenal — as they do for many traders — the focus shift
has him taking only the contra-trend ones that clearly reveal themselves
as a “I’d be stupid not to take it” trade. He doesn’t pursue them … they just
show up.