Ihave told my readers that one of the best methods to trade a market is to jump on board when prices “break out” of a congestion or “basing” area on the charts and begin a new trend. I have also stressed to my readers that one of the most risky and least successful trading methods is trying to pick tops and bottoms in markets. Now, I’m going to muddy the waters just a bit and discuss contrary opinion.
Contrary opinion in the trading business is defined as going (trading) against the popular or most widely held opinions in the marketplace. This notion of “going against the grain” of popular market opinion is difficult to undertake, especially when there is a steady drumbeat of fundamental information that seems to corroborate the popular opinion.
To help you understand why contrarian thinking is used successfully by some traders, consider these questions: When is a market most bullish? When is a market most bearish? The answers are: A market is most bullish when the highest daily high on the chart is scored–it’s downhill for prices from there. A market is most bearish when the lowest low is reached on the chart, and then the market turns up.
It’s no wonder many novice traders lose their assets quickly in the futures trading arena. Traders are most bullish at market tops and most bearish at market bottoms!
Since nobody has discovered the Holy Grail of trading markets, the best traders can do is seek out clues, through chart and technical analysis, and possibly do some contrary thinking.
If you’ve read books on trading markets, most will tell you to have a trading plan and stick with it throughout the trade. A main reason for this trading tenet is to keep you from being swayed or influenced by the opinions of others while you are in the middle of a trade. Popular opinion is many times not the right opinion when it comes to market direction.
I’ll give you an actual example of how contrarian thinking and trading can be successful. The year was 1988, the last big drought year in the Midwest that saw corn and soybean prices skyrocket. It was a Friday in July that saw corn and bean prices trade sharply higher, based on ideas the hot and dry weather would continue in the Corn Belt. Then, after the close, the National Weather Service issued its 6-10 day forecast that, sure enough, called for more hot and dry weather for the Corn Belt. Bulls confidently headed home for the weekend. Even “local” traders on the Chicago Board of Trade floor went home long–something most never do, especially over a weekend.
Well, come Monday morning, the updated weather forecasts had changed a bit, but more importantly, trader psychology had changed immensely. The drought and resulting poor yields had all been factored into the market with prior price gains, culminating with Friday’s big push higher. Corn and bean markets traded limit down on Monday and recorded very sharp losses for around three days in a row.
I know of one trader who used contrary opinion thinking and bought put options on corn that Friday that prices were pushing higher. He made a good deal of money that next week. But isn’t that top-picking? Yes, technically it is. But this trader used a low-risk trade by purchasing options and employed contrary opinion to score a winning trade. Contrarian trading is not for everyone, but some traders are successful in employing it.
For further reading on using contrary opinion in trading, there is a book called “Contrary Opinion” by R. Earl Hadady. He is the founder of Market Vane’s “Bullish Consensus.” This is a weekly report that provides traders’ degree of bullishness or bearishness in the major markets. Traders use this report to help them gauge when a market is overbought or oversold.