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Reasons to Trade Contrarian

3 April 2019 | Juan Breytenbach
 


Have you perused every single trading book you could get your hands on, followed all the "experts" on social media trading websites, watched copious amounts of CNBC/Bloomberg/BDTV, kept your stops tight, read all the SENS announcement’s, tried to let your winners run but yet you still walk away fruitless not taking profits you believe that you deserve to get from the market?

  • What do you do if there is no trend and the market is going sideways?
  • Do you find yourself in a place when you "let your profits run" that the trade comes back to stop you out?
  • When you take a "quick profit" the specific stock trades past your profit target with no indication of stopping?
  • What would you do if there is suddenly overnight a black swan event that occurs crushing your trend following system?
  • Are carry (interest) costs eating away too much into your profits?
  • Do you find yourself scalping a lot of very small losses which adds up eventually?
  • Do you go through very hefty drawdowns on your account?
  • Are you bearish on the market but keep shorting the bottom and can never stay short for when it really counts?
  • Does the market spook you out of positions, cutting before positions move to your stop loss just to watch them go straight to your target within a matter of weeks?

Are you looking to experiment with another type of trading strategy?

I believe the time then has come for you to become a: Contrarian trader

New legislation came out last year in Europe that all trading service providers and brokers need to stipulate the percentage of clients who lose money with them trading derivatives.

Now I present the following difficult question to you - if you are trading the way that the average “joe soap” trades, do you really believe you are going to beat the market?

If all the generic content available on the internet resulted in profitable trading results, as proclaimed, then why do only 28% of retail derivative traders make money on their accounts?

The longer I spend in the market, the more I see this, happen over and over again. To quote Mark Twain, “History doesn’t repeat itself, but it often rhymes”

So, the burning question you probably have right now is:

Tell me more?

How do I become a contrarian trader?

First a couple of things to note:

There is a big difference between being contrarian and being reckless.

Being contrarian isn’t shorting shares just because they are going up or buying shares because they are down, for example.

Being contrarian is looking for those specific signals that show things are going completely out of whack i.e. Remind yourself of what happened to Bitcoin.

When you break down the way markets trade, they only have 3 directions they can move; up, down and sideways.

Once you have identified which cycle we are currently in, then you will know which strategy is best to follow i.e. the best way to align your trading strategy or portfolio in order to make the most of upcoming opportunities.

There are a few nice trading strategies to explore and a couple of things you can look at that may indicate when you should be contrarian and when to “follow the herd”:

1. I find many people in a bull market (a market that trend upwards) try and short shares hitting highs and vice versa when markets are falling.

  • Have a look at the market breadth, Sharenet has a nice tool to explore.
  • Have a look at how many shares in the major index are above their 200 SMA (Simple Moving Average)
  • Another way to analyze and find what sort of strategy you should be running in the market is to examine the slope of the 200 SMA. This will give a good indication at the way you should be trading. When you find a steep sloping chart, follow it and when the slope of the moving average is almost flat then look to swing over to a mean-reverting strategy, i.e. short highs and buy lows, etc.

2. Another great free tool to use, on IG markets website you can find the percentage of retail client accounts that are positioned in a specific direction.

From my experience, once more than 70% of the market is long or short then there is a possibility that it could move in the opposite direction, once you see that occur, start to do your homework and if there is enough evidence to confirm that the majority of retail investors might be on the wrong side,  this might be a good contrarian trigger.

Remember just because 70% of the market is long doesn’t mean there is going to be a sell-off today or tomorrow, we usually see them hold for quite some time before the final pullback comes that flushes all the traders out of the market by triggering their stop losses.

1. The Put/Call ratio - I would suggest using this in a more developed market (i.e. the United States) as their options market is a lot more advanced than ours in South Africa. A rising put/call ratio indicates bearish sentiment i.e. more people buying puts than people buying calls and vice versa.

There are quite a few other indicators that we examine and share with our private clients who trade through us at Sharenet.

Now the fun part: How to trade your positions?

  • As the saying goes, "there are many ways to skin a cat". Something vital to remember when you are looking to venture down the contrarian path. There is no set rule or one way to trade contrarian, which makes it quite exciting.
  • There is also no "one size fits all" strategy, you need to understand the risk and the potential profits as well as your own personal level of comfort.

How much drawdown on your portfolio are you comfortable in taking as well as what is the max drawdown you are willing to have on a specific position within that portfolio.

  • Remember just because everyone is long doesn’t mean suddenly tomorrow, they will all be wrong, things like this usually take time to play out. You need to safeguard against that.
  • Look at your own strengths and weaknesses before you plan a strategy to trade, play into your strengths and mitigate your weaknesses.
  • Plan before you trade how long your investment horizon is. I see so many traders enter a position but don’t factor in the impact of the interest that eats into their profit or capital if they have to hold that specific position for a full calendar year.
  • Likewise, when shorting the market, remember on the JSE we are fortunate enough to earn interest on the short positions that we hold.

These are simply a couple of things to think about.

If you would like to discuss some trading strategies, please complete the form below and one of our dedicated traders will get in contact with you.

 

Juan Breytenbach
Sales Trader : Sharenet Johannesburg

Juan developed a passion for the markets and short/medium term trading early in life and decided to pursue a career as a professional trader back in 2012. He started his career at Vunani Private Clients, as a private client trader as well as in “principal” capacity before moving to Capilis Asset Managers (later acquired by Sharenet). Juan uses a holistic view when analysing market opportunities. He considers everything including technical and fundamental analysis, as well as Sharenet Analytics and other quantitative models to identify trade ideas as well as entry and exit levels. Juan is an avid sportsman and a big history nerd. He holds the designated Registered JSE securities trader, RE5 & RPE exams and is currently studying towards his B. Com Banking degree.


Disclaimer:
The information contained in this article is for informational purposes only and must not be regarded as a prospectus for any security, financial product or transaction. It is neither to be construed as financial advice nor to be regarded as a definitive analysis of any financial issue. Investors should consider this research/article as only a single factor in making their investment decision. We recommend you consult a financial planner/advisor to take into account your particular investment objectives, financial situation and individual needs. The views and opinions (where expressed) in this article are those of the author and do not necessarily reflect the official policy or position of Sharenet.

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