The counter-trend trading strategy goes against the market’s general direction. It’s not the easiest approach for beginners—getting started can be tough—but if executed correctly, the rewards can be substantial. This article aims to help you understand how this strategy works and how to apply it effectively.

What is a Counter-Trend Market?

A counter-trend market refers to a price movement that goes against the main trend. These corrections are usually small in size but may take more time to complete their consolidation patterns.

The Five Steps of Counter-Trend Trading

Can counter-trend trading be successful? Absolutely—but you need to follow a set of rules to get there.

Step 1: Identify the Start of a Counter-Trend Move — The Reversal Candlestick Rule

When a stock begins a strong move, the first thing you should do is draw a trendline. This support or resistance line will help you distinguish between the main trend and any corrections.

As the stock moves along its trend, watch closely for reversal candlesticks that could signal the strong move is ending. Before moving to Step 2, you must identify a candle that moves in the opposite direction of the main trend. This is the hardest step of the five, as it requires timing when the trend is likely to pause.

Based on my years of trading experience, one thing is consistent: any unexpected change in price direction usually happens in alignment with the main trend.

Step 2: Pattern Confirmation

There are two ways to confirm a reversal pattern:

  • Another reversal candle: Be aware that this rule can sometimes fail, as two opposite candles are not a strong confirmation on their own. Still, this method has a success rate above 50%, enough to support a profitable counter-trend strategy.
  • A reversal candlestick pattern: Another way to confirm a counter-trend move is to spot a candle that completes a reversal formation. This could be a single “hanging man” or “shooting star,” or it might be part of a double-bottom or triple-bottom pattern.

Example 1: Suppose you’ve identified a reversal candle (Step 1), then another candle appears that engulfs the first one. This forms a bullish or bearish engulfing pattern, confirming the reversal.

Example 2: After the initial reversal candle, another appears entirely within the body of the first. This creates a harami pattern, another sign of a possible reversal.

In both cases, you’ve confirmed a reversal in the strong trend, and thus, the start of a counter-trend move.

Step 3: Execute the Counter-Trend Trade

Once the counter-trend move is confirmed, it’s time to open a position.

  • If the main trend is bullish, the counter-trend is expected to be bearish, so you should consider opening a short position.
  • If the main trend is bearish, the counter-trend should be bullish, meaning you should open a long position.
Step 4: Set a Stop-Loss

Always set a stop-loss when trading counter-trend movements. Here’s how you might set it:

  • In a bullish trend, place your stop-loss above the peak formed between the trend’s impulse and the expected correction.
  • In a bearish trend, place your stop-loss below the bottom formed between the trend’s impulse and the expected correction.
Step 5: Taking Profit from the Counter-Trend Trade

Now that you know how to spot a potential counter-trend, when to enter, and where to set a stop-loss, the next question is: how long should you hold the trade?

The rule is simple: hold the trade until the price touches the main trendline during the correction. Once this happens, it’s time to exit.