In Part 1, we have reviewed the fundamental tools useful for long-term trading with contrarian trading strategies. In this Part 2, we will see how technical tools may be used for short-term trading with this type of market approach.
Contents:
Interact with the dashed blue word and green spot on images to get additional details and explanations.
Contrarian Trading Strategy with Indicators
Moving Averages
Moving Averages are one of the easiest ways to check if a trend is going to reverse or end.
The 200-period Moving Average is especially useful for that. Look at the GBP/USD chart below on the 1d time frame.
You may notice that the price has strongly deviated from the Moving Average. This usually means that a correction will come soon.
This method is good to forecast future price behavior. However, it doesn’t suggest exact entry points. To identify those, we can use the Bollinger Bands indicator.
Bollinger Bands
With Bollinger Bands, we will be looking for a spot where the price moves far outside the bands. In this case, the Japanese candlestick, or bar would form completely outside the bands.
Let’s have a look at Amazon's stock price chart in the 4h time frame below.
As you can see, the price moved well outside the lower Bollinger band. Afterward, it quickly returned to the middle band of the indicator presented by the 20-period Simple Moving Average.
Like most indicators, Bollinger Bands require additional confirmation to work effectively. The RSI indicator is one of many indicators that may provide additional signals.
Relative Strength Index
On the Amazon stock chart below, when the price left the Bollinger Bands area, the RSI indicator was already in the oversold zone.
When the price returned inside the bands’ area, the RSI also returned from the oversold zone. Thus, the indicator confirmed the downtrend’s end and the upside reversal.
This method can be applied on any time frame including for contrarian day trading.
Contrarian Trading Strategy with the News
You can practice contrarian trading on the news. For that, you need to follow the news releases as they usually cause increased market volatility that is potentially profitable. Olymp Trade platform’s Insights may help find the most impactful news.
With this approach, be prepared that there is often strong upward or downward movement on the market when news comes out.
Let's look at EUR/USD behavior during the Non-farm payrolls release on February 04, 2022 on the 5m chart below.
The released +467K of the Non-farm employment increase in January was much better than the forecast of +150K. That boosted USD, leading to a drop in the EUR/USD pair. Later however, the pair recovered the loss.
The following formula describes the usual effect of the news on the market.
I=1T2
In this formula, I is the net impact, and T is the time elapsed since the news release.
According to this formula, the net influence in the first minute after the news release is 100%. In the second minute, the net influence drops to 25%. Then in the third minute, it is 11%, and so on.
Based on this pattern, you can open trades in the opposite direction to the market trend or against the crowd a few minutes after the news release. The idea is that after the news recovery, the market returns to its normal values. That's what happened on February 4, when EUR/USD recovered to almost the same levels where the decline started before. The charts below demonstrate that.
After learning this strategy, you may also want to refresh your knowledge of technical indicators or learn more about how news affects markets. Check out our articles on technical analysis and fundamental analysis. They will likely be helpful.
As for the strategy, how do you like it? 🙂
We suggest you try using it in practice. You can train on the Olymp Trade demo account applying the method above, and use the contrarian trading strategy to profit on your live account when you’re ready. Feel free to share your experience with other Olymp Trade users in our social media. We look forward to hearing your success stories.
Trade NowRisk warning: The content of the article does not constitute investment advice and you are solely responsible for your trading activity and/or trading results.
