Forex Trading: Contrary Opinion And Momentum Indicators



Posted: Friday, October 23, 2009

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Contrary opinion is a trading strategy that was published and made popular in the early 1980's for the commodity futures market. This is a simple trading strategy to understand, and while the logic behind this strategy can be argued back and forth because it is a radical idea, even almost 25 years since the original theory was published it can still hold true in many of our financial markets and can yield great rewards to those traders willing to take the risk of basing trades on this theory.

The premise of contrary opinion trading is that when all of the other traders in the market expect the value to go up, it will go down, and when all of the other traders expect the value to go down, it will go up. The reason this can work is because everybody who expects the market to go up has already bought the currency pair, and so there is no more buying power to maintain the trend. Now if you have ever read anything about trading with a momentum indicator then the logic behind this type of trading strategy may sound familiar, because it is likely that you were told to sell when the market is overbought and buy when the market is oversold.

On the price chart of the currency pair you are trading, you can use an indicator called the relative strength index combined with contrary opinion to find your trading signals. Contrary opinion states that you should sell when other traders expect the market to go up, but since the foreign exchange market is not traded on a central exchange then how can you have access to this information? The answer is that the mathematical equations behind indicators like the relative strength index can fairly accurately relay this information according to the price behavior, and so once you know how to read these indicators you will know what the prevailing market sentiment is.

The RSI will list a current value between 0-100 with 50 as the center point, and as a general rule of thumb a value above 75 indicates overbought and a value below 25 indicates oversold. You can use this indicator to find the right point where buyers have bought into the market expecting it to rise, but the RSI value begins to move from its current overbought condition back to the center line of 50. When this starts to happen it can be your signal that there is no more buying power left to sustain the trend and the market will begin to fall.

Who Is Taking The Opposing Side Of Your Trades?

When you trade on the retail foreign exchange market, you are buying one currency and selling another, and in order for market liquidity to exist in this format there must be a counterparty to your trade. If you are buying dollars and selling pounds, there must be someone else to take the opposite side of that trade. One of the reasons that contrary opinion can work very well under certain circumstances is that all of the traders who think the market will go up are the ones who can take the opposing sides of your trades when you need to sell.

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Ricky Weber is the forex author for http://TheCurrencyMarkets.com
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