Counter-Trend Trading

Here is an extremely simple trading system that violates the classic rule of trading, trend is your friend, with very good results. It is an excellent example that illustrates how counter-trend approaches work.

Simple Range Exhaustion System

1. Calculate the daily 20 period average range.

2. Today’s range must expand to exceed #1.

3. The 2-day combined range must expand to exceed 2.2 times of #1.

4. Go long at market if the market is trading in the lower portion of the 2-day range.

5. Protective stop is placed at 0.35 times #1 from the entry price.

6. If not stopped out, exit by 16:00 Eastern Time. i.e. a day trading system

To understand what the system does, just think about a rubber band that stretched thin. Once the force that hold up the stretched rubber band is gone, the rubber band will snap back to its normal self. Similarly, when the market moves in a particular direction too fast too soon, it will then snap back to a more sustainable level.

Almost all counter-trend trading techniques are based on similar principle. As oppose to wait for a confirmation before taking a position like trend followers, most counter-trend traders will try to time their entries as close to the extreme reversal points as possible to maximize the profits and minimize the risk exposures.