Updated from its original posting on 2012-12-14
When all charts point to a single direction and the current market sentiment is supported by the newswires, it’s easy to understand why many forex traders hesitate to go against the herd. But as investment pundit Warren Buffett famously said, “We should also be fearful when others are greedy and greedy when others are fearful.”
You see, just because a majority of the forex traders out there have a certain trading bias, it doesn’t necessarily mean that they’re right. Sometimes, strong momentum merely reflects the entrance of trading amateurs that just go with the flow without knowing what’s driving price action. This is why following the flock blindly can lead to herding bias – one of the 5 common trading mistakes traders make.
Ask anyone who has successfully tried trading against the herd and they will tell you that it can feel intimidating when your analysis leads you to an unpopular bias. But sometimes, it pays to go against the herd and be the odd one out – to be the contrarian.
Contrarian trading is a trading strategy that favors going against the current market bias in anticipation of a shift in market sentiment. It involves buying a currency when it is weak and selling it when it’s strong.
Contrarian forex traders try to take advantage of moments when the markets get carried away by strong momentum. When everyone and his grandma is ready and willing to push prices higher, it can sometimes lead to overpriced assets. Likewise, when everyone is hell-bent on selling a currency, opportunities to buy at a bargain arise.
One of the main benefits of contrarian trading is that it allows you to get good prices and catch reversals right as they begin. In turn, this often leads to very attractive reward-to-risk ratios, giving you more bang for your buck.
However, contrarians trade against the trend, and that doesn’t always work out in their favor. As the saying goes, “the trend is your friend,” but it can be a mean son of a gun when you fight it. When a trend is particularly strong, it can bust right throw potential reversal points and wash away those who go against the flow.
By no means am I saying that you should go against the trend just for the heck of it. What I’m merely saying is that if, after thoroughly conducting your own fundamental and technical analysis, you have enough reason to believe that the forex market is about to turn, don’t be afraid to go against the herd and take a contrarian position.
Remember, you don’t always have to go with the flow; plenty of lucrative trading opportunities arise from straying from the crowd. But always keep in mind that although contrarian trading can be rewarding, it’s not without its dangers.