Last updated on July 6th, 2017 at 04:58 pm
Mechanics behind not trading against a trend
We’ve all heard of the warning not to trade against the trend. This guide explains in layman terms why.
The short and sweet answer is that in an uptrend, there will be buyers below. In a downtrend, there are sellers above. So you could try to trade against a strong trend, but chances are it wouldn’t go very far, unless there has been a bull trap (picture explanation below).
To put it more accurately, you can trade against a trend, but don’t expect a major move unless there is a bull/bear trap.
Let’s break it down with a layman explanation. Let’s say you are a hungry beggar with only $1 left. You haven’t eaten for days and you hope to buy some apples to fill your tummy. You visit the nearby marketplace and watch the prices of apples.
On day 1, an apple costs $0.70. Day 2, the price rises to $0.90. Day 3, $1.20. Day 4, $1.40. You start to think. Oh shit, I can’t afford the apples. The price is rising so fast. I hope the prices fall so that I can buy some.
On Day 5, the prices fall to $1.00. Would you buy it? As a hungry beggar who hasn’t eaten for days, and who has exactly $1.00 AND (most important part) who has seen the price RISE steadily over the past 4 days, I’m quite sure you will buy it.
Because in your mind, you are thinking that the prices are PROBABLY going to rise further, given the uptrend over the past few days.
This is what I mean when prices aren’t going to go very far against the trend. There are buyers below waiting to snap up the apples at a discount relative to the prior uptrend. And hence, you are most likely going to see a second wave up.
Real world example
GBPAUD H1 chart, April 5- 6 2015
PS: This is a real trade that I took, not just on hindsight.
What is a bull trap?
Earlier, I mentioned “you can trade against a trend, but don’t expect a major move unless there is a bull/bear trap.”
Here’s a pictorial explanation
PS: These are real trades that I took, not just on hindsight.
There you go! Mechanics behind not trading a against a trend. I hope these pictorial explanations help you internalise the logic behind not expecting a major move against the main trend.
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