One of the popular problems traders suffer from is trading against the trend, whatever the time frame. There are compelling reasons as to why you shouldn't trade against the trend.
Higher Losses When trading against the trend, you are essentially 'betting' against the prevailing market sentiment. Trends, whether upward or downward, indicate the overall direction in which the majority of traders and investors are moving. Going against this flow means you are challenging the collective wisdom of the market. Since trends often continue longer than expected, trading against them increases the likelihood of sustaining losses.
Decreased Probability of Success Statistics and historical data show that trading with the trend has a higher probability of success. Trends often persist due to momentum and market psychology, which means that once a trend is established, it is likely to continue. Conversely, trading against the trend means you're placing a bet on a market reversal, which is inherently less probable and more difficult to predict accurately.
Psychological Stress Trading against the trend can be psychologically taxing. Watching the market move consistently against your position can be stressful and can lead to emotional decision-making. This stress can cloud your judgment, leading to impulsive decisions that can exacerbate losses. In contrast, trading with the trend often aligns with the market movements, reducing stress and allowing for more rational decision-making.
Increased Transaction Costs Frequent trading against the trend can result in higher transaction costs. As you try to capture short-term reversals or counter-trend movements, you may end up making more trades. Each trade incurs costs such as spreads, commissions, and slippage. These costs can add up, eating into your profits and exacerbating losses.
Missed Opportunities When you focus on trading against the trend, you may miss out on more straightforward, profitable opportunities that come from trading with the trend. Trends often represent the path of least resistance in the market, and aligning your trades with this direction can lead to more consistent and predictable gains.
Technical Analysis Reliability Many trading strategies and technical analysis tools are designed to work best when trading with the trend. Indicators such as moving averages, trend lines, and the Relative Strength Index (RSI) are more reliable when used in the context of an existing trend. Trading against the trend often renders these tools less effective, reducing their predictive power and the effectiveness of your strategy.
To illustrate, the below price action is the EUR/USD on the weekly time frame. This is an excellent time frame to capture without any ambiguity, what is happening with price and what the directional trend is. The higher the time frame, the more accuracy.
Price had fallen very steeply as evidenced by the words in the image 'strong trend'. After reaching a bottom, price did move up again as expected as there will always be a market reaction eventually where the bulls will, at least temporarily, overpower the bears. In the example above, the bulls, after a larger pull back, followed by a consolidation, are getting stuck at the larger downward trend line.
During the strong trend, a trader would have to be very brave to take a long position on the 'gamble' that price was reversing. A true and confirmed reversal would only be in play, if price would break the downward trend line and ideally come back and test that level after breaking it.
See the extract of the price action from the EUR/USD on the 4 hour chart, which is part of the price action highlighted in the weekly chart.
This chart demonstrates that classic trending move with constant downward legs, with retraces. There tend to always be a few false breakouts that quickly get shorted to go back into the underlying trend continuation.
In terms of psychology, why do people trade long when the trend is going down? I can't speak for others but it is a mistake that I have made on numerous occasions, particularly when I first started trading. Part of the problem is the human nature of feeling that you are buying a 'bargain'. This is a dangerous opinion to have when you are putting money on the line. The facts are that price is going down and there is no evidence being presented during the trend that would suggest the bias has shifted to bullish. The majority of traders that went long while on the move down lost money.
For reversals, in trending markets, it is safer to trade with the trend. To keep yourself grounded, look at the 20 period moving average. Moving averages are based on historic price action but in a downward trend, it is high risk to go long when it has historically stayed at prices below the average of the last 20 candles.
Trade Clearly!
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