Proven ways to trade against the crowd effectively ?
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One of the most compelling reasons why most breakouts tend to fail is due to the fact that winners need to take money from losers, and it does not always pay to have the same mentality as the crowd, as the majority will crash out of the trading game broke.
Money has to be made from the majority, not from the minority who get it right. The crowd holds the dumb money with weak hands, whereas the smart money tends to belong to the domain of big players who can afford to reach into their deep pockets for a couple of tricks to sabotage the crowd.
The most money is made when the crowd turns out to be wrong, because then these players will scramble to get out of their losing positions, causing vertical rallies or declines. If almost everyone, ranging from people hanging out in online forums to your neighbors, see the same great opportunity to buy above a resistance level or sell below a support level, who will be the sellers on the other side of the transaction?
For someone to buy something, there must be a seller, and vice versa. Granted, there are not too many traders who are indeed unaware of such a level, so how can the majority make money from the minority? If there is so much market demand to buy above a resistance or sell below a support, the market maker has to absorb all those one-sided orders and take the other side of the equation. However, we must be aware that the market maker is certainly no fool.
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Almost everyone is taught the same aspects of technical analysis from books or other sources, and new traders are the ones who tend to most eagerly follow trade recommendations stemming from the formation of certain chart patterns on the currency price charts.Retail traders like to trade breakouts, but institutional, or the more seasoned traders, prefer to fade breakouts, doing exactly the opposite of what the majority is expected to do.
That is one of the main reasons why most breakouts fail – the institutional or seasoned traders taking advantage of the crowd psychology of the retail or inexperienced traders, and winning at their expense. Our strategy is to trade in the direction of institutional activity, by fading breakouts.
Their game plan is to make money from the majority of the crowd who thinks that the price will rally merrily after an upside breakout or decline dangerously after a downside breakout. Since market makers are the pricing counterparties to their retail customers, they have to take the opposite end of your trade, whether you like it or not.
First of all, let’s see things from their point of view. For example, if there is an expected crowd demand to buy at a certain price above a resistance level, these firms know that they will have to sell to their customers, so how will they position themselves in an advantageous position?
What they routinely do is that they reach into their pockets, spend a bit of money buying up the currency pair to the level where stop entry (and stop-loss) orders have been placed by their customers, so that they can now sell to those people who are desperate to buy, thus making some decent profits from this trick.
The next stage of this trick comes when customers’ stop (both entry and exit) orders are triggered and the retail crowd goes long. This gives the market makers and other big players a chance to close the previous longs they entered by selling to the crowd. However, the big players know they can make money in both directions, so now they begin shorting to overwhelm the buying pressure from the crowd, thus pushing the currency prices down, back below the breakout level, where many stop-loss orders have been placed by the buyers who trade the upside breakout.
These stop-loss orders then become executed, and the big players can gleefully offload all or some of their shorts by buying from those who are selling to close their losing breakout trades.
This is the story behind the false breakout – beautiful in the eyes of big institutional players; hideous and greatly undesirable in the eyes of the crowd. Hedge funds, with their immense capital, can play these tricks on the unsuspecting crowd as well, even though they trade only for themselves. Market makers have the information of where their customers’ orders are from their order book.
Even if these big players have good intentions, they could still potentially trade against you so as to cover imbalanced trades or to supply liquidity to the market. Of course, trading to maximise profits of their internal accounts cannot be ruled out.
A potential conflict of interest can thus exist, and retail traders must know that in order to know how to protect themselves. After all, market makers exist to give profit to their share-holders, not to their customers. When big players go on a stop hunting spree, false breakouts are likely to be the consequence of that.
The crowd may think that the false breakout is due to the sudden turning of the market, but it is most likely the direct result of the games that big players play. Taking out stops placed by the crowd at predictable levels serve their monetary interests. Retail traders must know what these big players are doing
False breakouts also arise when market makers execute stops before the interbank market has reached those prices or execute stops that lie just outside the actual trading area. Sometimes you may see that prices have pierced slightly through the breakout level in intraday charts, or even longer-term charts like the daily charts, and then make a quick U-turn back into the pre-breakout price zone.
False breakouts do not just happen because of the tricks institutional players use; they could also be the result of the market running out of steam to reach higher or lower lows in a sustained price break. This situation occurs when there are not enough fresh buyers to sustain an upward price move or fresh sellers to sustain a downward price move.
The lack of new blood into an already very long or short market often heralds an unexpected turn of the market as the market move becomes attenuated.
Even though fading breakouts is counter-intuitive, it can be a very profitable strategy for capturing short-term gains. In order to maximise the effectiveness of this strategy, you need to go through some analysis steps which will guide you as to where and when you can fade a price breakout with a higher probability of success. The key points to look out for are the location and the timing.
You can use false breakouts to your advantage instead of seeing them as your enemies. The first question to ask is: where do false breakouts usually occur? False breakouts can be found anywhere on the currency price chart at levels of support and resistance, which may manifest in the form of trendlines, chart patterns or previous daily highs or lows.
I recommend that you look for opportunities on a minimum time frame of hourly or more. There are really no hard and fast rules regarding the entry criteria, as there is absolutely no way of predicting with 100% accuracy the next price movement.
Money has to be made from the majority, not from the minority who get it right. The crowd holds the dumb money with weak hands, whereas the smart money tends to belong to the domain of big players who can afford to reach into their deep pockets for a couple of tricks to sabotage the crowd.
The most money is made when the crowd turns out to be wrong, because then these players will scramble to get out of their losing positions, causing vertical rallies or declines. If almost everyone, ranging from people hanging out in online forums to your neighbors, see the same great opportunity to buy above a resistance level or sell below a support level, who will be the sellers on the other side of the transaction?
For someone to buy something, there must be a seller, and vice versa. Granted, there are not too many traders who are indeed unaware of such a level, so how can the majority make money from the minority? If there is so much market demand to buy above a resistance or sell below a support, the market maker has to absorb all those one-sided orders and take the other side of the equation. However, we must be aware that the market maker is certainly no fool.
TRADING AGAINST THE CROWD
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I have increasingly noticed that obvious support and resistance levels on the currency price charts tend to provide the best opportunities for fading breakouts,although it is not always the case. This is not surprising, given the fact that the most well-recognised price levels or chart patterns will be detected by the majority of traders.
Almost everyone is taught the same aspects of technical analysis from books or other sources, and new traders are the ones who tend to most eagerly follow trade recommendations stemming from the formation of certain chart patterns on the currency price charts.Retail traders like to trade breakouts, but institutional, or the more seasoned traders, prefer to fade breakouts, doing exactly the opposite of what the majority is expected to do.
That is one of the main reasons why most breakouts fail – the institutional or seasoned traders taking advantage of the crowd psychology of the retail or inexperienced traders, and winning at their expense. Our strategy is to trade in the direction of institutional activity, by fading breakouts.
TRICKS OF INSTITUTIONAL DEALERS AND TRADERS
Before I talk about the Breakout Fading Strategy, let’s understand a bit more about the kind of tricks that are played by institutional dealers and traders. Many market makers, banks, and hedge funds – mainly big players with deep pockets – are known to fade breakouts, which are traded by many retail traders.
Their game plan is to make money from the majority of the crowd who thinks that the price will rally merrily after an upside breakout or decline dangerously after a downside breakout. Since market makers are the pricing counterparties to their retail customers, they have to take the opposite end of your trade, whether you like it or not.
First of all, let’s see things from their point of view. For example, if there is an expected crowd demand to buy at a certain price above a resistance level, these firms know that they will have to sell to their customers, so how will they position themselves in an advantageous position?
What they routinely do is that they reach into their pockets, spend a bit of money buying up the currency pair to the level where stop entry (and stop-loss) orders have been placed by their customers, so that they can now sell to those people who are desperate to buy, thus making some decent profits from this trick.
The next stage of this trick comes when customers’ stop (both entry and exit) orders are triggered and the retail crowd goes long. This gives the market makers and other big players a chance to close the previous longs they entered by selling to the crowd. However, the big players know they can make money in both directions, so now they begin shorting to overwhelm the buying pressure from the crowd, thus pushing the currency prices down, back below the breakout level, where many stop-loss orders have been placed by the buyers who trade the upside breakout.
These stop-loss orders then become executed, and the big players can gleefully offload all or some of their shorts by buying from those who are selling to close their losing breakout trades.
This is the story behind the false breakout – beautiful in the eyes of big institutional players; hideous and greatly undesirable in the eyes of the crowd. Hedge funds, with their immense capital, can play these tricks on the unsuspecting crowd as well, even though they trade only for themselves. Market makers have the information of where their customers’ orders are from their order book.
Even if these big players have good intentions, they could still potentially trade against you so as to cover imbalanced trades or to supply liquidity to the market. Of course, trading to maximise profits of their internal accounts cannot be ruled out.
A potential conflict of interest can thus exist, and retail traders must know that in order to know how to protect themselves. After all, market makers exist to give profit to their share-holders, not to their customers. When big players go on a stop hunting spree, false breakouts are likely to be the consequence of that.
The crowd may think that the false breakout is due to the sudden turning of the market, but it is most likely the direct result of the games that big players play. Taking out stops placed by the crowd at predictable levels serve their monetary interests. Retail traders must know what these big players are doing
False breakouts also arise when market makers execute stops before the interbank market has reached those prices or execute stops that lie just outside the actual trading area. Sometimes you may see that prices have pierced slightly through the breakout level in intraday charts, or even longer-term charts like the daily charts, and then make a quick U-turn back into the pre-breakout price zone.
LACK OF FRESH BLOOD
The lack of new blood into an already very long or short market often heralds an unexpected turn of the market as the market move becomes attenuated.
IDENTIFYING THE OPPORTUNITIES
Even though fading breakouts is counter-intuitive, it can be a very profitable strategy for capturing short-term gains. In order to maximise the effectiveness of this strategy, you need to go through some analysis steps which will guide you as to where and when you can fade a price breakout with a higher probability of success. The key points to look out for are the location and the timing.
WHERE POTENTIAL FAKEOUTS OCCUR
I recommend that you look for opportunities on a minimum time frame of hourly or more. There are really no hard and fast rules regarding the entry criteria, as there is absolutely no way of predicting with 100% accuracy the next price movement.
TRENDLINESThere are similarities between riding a trend through trading trendline bounces which I have covered already, and trading false breakouts of trendlines. In both cases, we are expecting the price to bounce off the trendline, whether the price has or has not touched, or has pierced slightly through the trendline.
I have observed that the probability of a false breakout is higher if the trendline has a gentle gradient of slope, especially if it is angled at 45º or less. You don’t have to auge that with a protractor; just a visual analysis will do. Such a gently sloping trendline can usually be drawn by connecting at least two extreme points of highs or lows over a long period of time, depending on whether it is a downtrend or an uptrend.
There should ideally be some decent amount of open space between these two or three extreme points of contact, indicating that prices have deviated away from the trendline in the direction of the current trend
Usually, the third or even fourth extreme point of contact on the gently sloping trendline presents a good fading opportunity, especially if a moving average lies slightly below the ascending trendline or slightly above the descending trendline.
The speed of price movement preceding the approach to the trendline must also be considered. If prices are approaching slowly and steadily towards the trendline, then a false breakout or a trendline bounce would most likely occur.
On the other hand, a fast and high amplitude move could very likely result in a successful price breakout of the trendline with a sustained follow-through in prices, aided by the boost of momentum. In that case, it is better to refrain from fading the breakout.
BEST MARKET CONDITION TO FADE BREAKOUTS
Adopt the Breakout Fading Strategy only when you sense a high probability of the market situation supporting it. Not only must you spot a good location to carry out this strategy, perfect timing is also a key ingredient to spotting an ideal fading opportunity. From my experience, the best market condition for fading breakouts is a range-bound market.
RANGE-BOUND MARKETS
The forex market is no exception, and tends to stay range-bound most of the time, in between trending phases. Fading breakouts can be a very profitable trading strategy when the market is ranging. A range is bound by a support level and a resistance level which are in close proximity to each other, as buyers and sellers of a currency pair battle it out after either side has established an extreme overbought or oversold price zone.
This period of consolidation settles the currency prices within a range, and may be manifested in the form of a rectangle (a horizontal channel) or a triangle, whereby neither bulls nor bears of a currency pair are stronger than the other. At some point, either the bulls or the bears will wrestle control and overpower the other party, marking the start of a trending phase again.
A trading range should consist of at least two contact points at the support and at the resistance levels drawn. It is preferable to fade breakouts at the third or even fourth contact points at these levels on the hourly or daily charts as they tend to be more reliable.
Fading breakouts in a rectangle or triangle involves buying at the support line and selling at the resistance line at the third or fourth contact point on either side, unless there are overwhelming signs that the market is ready to trend again.
About Kuldeep Nikam
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