Picking Tops and Bottoms: Is It for You?

After years of talking to my trader friends and other forex fanatics, I noticed a pattern that seems to pop up pretty often when talking about losing trades.

As it turns out, more and more traders are losing their trades and even getting their accounts blown up by trying to short at the “top” and going long at the “bottom.” In fact, while it may not be the number one cause of death of traders’ accounts, I can say that it’s still pretty high on the lists.

Take Dan F. Xavier, a young trader I met at a convention recently. He told me how he was so confident about shorting EUR/USD at 1.4000 because he thought that the strong rally would end at that major technical level. His friends also shorted similar pairs for the same reason. They ended up losing almost half of their accounts when risk appetite continued to dominate the markets for the next couple of days, even taking EUR/USD to the 1.4250 area.

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Don’t get me wrong, I certainly understand the appeal of trying to pick tops and bottoms. The promising reward-to-risk ratios alone are too tempting, especially when the setup is supported by major technical levels.

Unfortunately, many traders pick tops and bottoms not for fundamental and technical reasons, but for the simple satisfaction of being right. After all, who wouldn’t want to say to their friends or post on MeetPips.com that they shorted at the top or went long at the bottom of a strong move?

But just because picking tops and bottoms present good reward-to-risk ratios it doesn’t mean that everyone should jump in at every opportunity. Here are three reasons why you should think twice before trading them:

1. More often than not, you’re not really looking at a top or bottom.

Ask any pro trader you know and he/she will tell you that picking a top or bottom is like catching a falling knife or standing in front of a speeding truck. Come to think of it, they usually end with the same bloody results (at least for your trading account).

A good explanation for this is that there’s a good chance that the technical levels that you’re looking at are not the ones the other traders are watching. Also, the other factors driving the trend (sentiment, fundamentals, etc.) might still be valid at a time when you think the pair is forming a top or bottom.

2. The subconscious need to be right from picking a top or bottom increases the danger of poor risk management.

Trying to predict a reversal can be tough, especially since you know in the back of your mind that you’re going against the current. In countertrend trading, it’s easier to mistake a retracement on the long-term time frame for a “reversal” on the shorter-term time frames.

Even more damaging is the misleading mindset that one can beat the market by pinpointing where exactly it will turn. This causes many traders to veer from their trading plans by placing tighter-than-usual stops and failing to let their profits run.

3. Countertrend trading takes experience

Although there are instances when both fundamental and technical analysis hint at a reversal, there will never be a guarantee where EXACTLY the market will turn. Not giving your trade enough breathing room for such potential reversals could be damaging to your account in the long run.

This is also probably why some seasoned traders caution against picking tops or bottoms. Taking countertrend trades demands a lot of market experience yet even some pros recommend that 90% of your trades should go with the trend.

With a lot of experience, and after doing your homework, picking tops and bottoms is just as good as any trading technique as long as you ALWAYS remember to practice proper risk management and give your trade enough leeway in case the market reverses a bit farther away from your predicted turning point.

Also, if you’re using a mechanical trading system designed to identify reversals, make sure to test the results on a demo account first or start out with small position sizes in live trading. Good luck!

  • Goldboner

    I’ve spunked most of my equity trying to pick tops and bottoms – for me it’s a mugs game. Trading with the trend only has put my account back in order and turned my trading around 100%. I use fib value EMAs (21 34 55…233) (looks nice and organic) and use them to identify trend and dynamic S&R. I always trade AWAY from the moving avarages. Using this method really is like “picking money up off the floor”

  • Schnitzel

    i like to trade corrections from overbought and oversold zones a lot, but it is difficult to say wether a pair is really retracing (and at one point it must retrace) or if it’s just going further or just going sidewards before going further.. it’s kind of gambling if the market is very unpredictable like it is at the moment

    • Nihalbhat

      yes. but even a small retrace is enough for a scalper with a good spread ECN forex account.

  • Nihalbhat

    can be done. but noone can predict exact top/bottom. u are going to get drawdowns and some will stop out. having too large stop loss, means those will get hit from time to time  - hard to recover. a fine balance is required. too small stop loss, just giving money to broker.

    key is entry technique and strategy. cater stop loss to individual trade with risk reward ratio in mind, not standard stop loss.

    if you get reversal right, you can gain almost immediately a large amount and if its a sharp reversal, it could be your weeks worth of gain in 1 trade.

  • Harry Pilgrim

    Picking the top is hard, but picking tops is easy. Drip feed in many small trades rather than a single big one. The higher it goes, the more units you wish to sell. Manage the downside by hedging using a correlated pair. 

    This is the easiest and most reliable method I have found. No losses!

  • Beldean Ciprian

    Before picking a top or bottom , i always say: If you are a fish , what direction is better to swim to ? :)

    I got burn a couple of times trying to pin point a bottom or a top, however sometimes you get a good reward

  • Leonardo

    seriously, i have not been good in trading the trend. I have develop a system in picking tops or bottoms and had been good in doing it. Like the NU pair this few weeks, though positively correlated with AU was an example of that trade.

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