Counter-trend trading: How to Identify a Valid Counter-Trend Price Action Setup

 

Counter-trend trading should only be attempted by traders who have already mastered trading with the dominant daily trend. Beginners should always learn to trade with the trend first, but as you progress you will want to know what to look for in counter-trend setups, because sometimes there are some worth taking.

Sometimes it’s OK to trade counter-trend, but there needs to be a structure behind how you do it; you should add this structure into your Forex trading plan. Most trades should be taken with the trend, but there are times when it’s warranted to trade against the recent market momentum or dominant trend. Keep in mind, and I want to really STRESS THIS: these worthy counter-trend opportunities are RARE, but THEY DO occur, and because I see so many members’ over-trading and taking counter-trend trades they should not be trading, I hope this article will clarify the issue. 

Nial’s steps to identify a valid counter trade that is worth taking: 

1) I only take counter-trend trades from the daily chart. Trading counter-trend on the 4hr or 1hr is extremely difficult and I do not suggest you attempt to do this. There really is no point since any valid counter-trend signal should also manifest itself on the daily chart. Basically, any counter-trend trade that is going to have enough follow-through to be worth risking your money on, is going to make itself evident on the daily chart 

2) Counter-trend price action setups need to stick out like a sore thumb. Basically, if you have to squint and analyze your chart or ask other traders if they see the same counter-trend signal…it’s probably not worth taking. Counter-trend setups that are worth trading are usually very well-defined, have long-tails in the case of pin bars, or show a clear rejection / hesitation. Ideally, you want the close of the price action setup to be in your favor when trading counter-trend. So, if you get a bearish pin bar counter-trend setup, you want the close lower than the open (opposite for bullish setup), this is very important in counter-trend signals because it shows there was follow through against the momentum into the market close, which implies there may be more follow-through to kick-off a larger counter-trend move. 

3) Counter-trend signals typically need to form at “core” / obvious support or resistance levels. Most of the time we need to see a core level of support or resistance combined with the counter-trend setup. This level should be a daily chart level and should be painfully obvious…there should be no doubt the level is significant and that it has rejected price forcefully at least one or two times previously. 

However, sometimes you might find a good counter-trade that’s not at a core level. These situations occur when a market is making new highs or lows and then forms a volatile “blow-off” top or bottom, which usually will be a pin bar. I will show an example of this below. Keep in mind, trading against a market making new highs or lows is very tricky and should not be attempted by amateurs, markets can keep going for far longer than you might think and you don’t want to be a top or bottom picker. However, the point is that sometimes you will get a very large reversal signal in these situations that essentially “creates” a new support / resistance level, but it needs to be very obvious, large, and well defined. 

So, basically the three important things to consider when analyzing a counter trend signal are the following: 

1) Is it on the daily chart? 
2) Is it large and (or) well-defined?
3) Where is it occurring at? Core level? If not at a core level is it “creating” is own level? (discussed above)

Special considerations: Inside bars and fakeys 

I get multiple emails each week from traders asking me if they should trade an inside bar against the trend if it turns into a fakey. The answer is no, not usually. Inside bars are primarily trend-direction setups, they can be traded counter-trend but they need to occur at a core level or event area. You really should only trade inside bars with the trend until you truly feel you have fully mastered them. 

You would not automatically trade a fakey against the trend just because it was an inside bar that didn’t work out. The same rules discussed above would apply; so you would only trade a counter-trend fakey if it follows the three points I talked about above… not JUST because it formed after an inside bar that failed. 

Examples of valid / good counter-trend trades vs. bad ones:

In the image below we see the daily AUDUSD; we can see this was a valid counter-trend inside bar trade setup for the following reasons: 

1) The setup was on the daily time frame.
2) It was a well-defined inside bar setup, it was actually an inside-pin bar.
3) The setup formed at a core resistance level that had previously seen a strong rejection and resulting move. This was also an event area since a pin bar formed here previously as seen in the chart below