A common belief amongst forex traders is that the big profits are made by looking for overbought and oversold positions, particularly on the longer time frames such as the 4 hour, daily and weekly charts. However is it really a good idea to trade against the overall trend, and should you consider employing such a strategy yourself?
Well when I first started out as a forex trader I was obsessed by this style of trading. I used to spend hours on end playing around with indicators such as the CCI, RSI and stochastics indicators in order to find currency pairs that were either overbought (so I could identify shorting candidates) or oversold (for opportunities to go long).
The trouble was that although I did make some big profits on occasions, there were also several occasions when these indicators turned out to be pretty much useless and the price just carried on moving in the direction of the trend. This is the major problem with trying to constantly try and find the end of a particular trend. Sometimes the price will indeed reverse back in the opposite direction but sometimes the price will just keep on going with the trend.
Another problem you face is that sometimes these overbought or oversold points do indeed signal a reversal, but the reversal turns out to be a short-lived one. Therefore as soon as the initial trend continues you are going to lose money if you haven’t already banked any profits.
This is why I personally believe that employing contrarian trading strategies is a very dangerous game when trading the forex markets. In general you’re much better off coming up with a trading strategy that enters a trade in the same direction as the overall trend. This way you know that the odds are on your side because if you mistime your entry point, there is still a chance that the trend will resume and return you to profitability.
Of course this does mean that you miss some of the big price reversals that take place but it’s much easier to trade the middle part of an existing trend rather than constantly trying to identify the start of new trends all the time.
So to sum up, I personally would advise against using contrarian trading strategies because it’s a very difficult way of trading the markets. Every single one of my own systems trades with the trend and I would argue that the vast majority of the most profitable trading systems are trend-following systems as well.
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