Contrarian traders base their trading strategies on the underlying principle that the market tends to overreact at both extreme highs and lows.
Contrarian traders see these extremes as opportunities to profit from sharp reversals that can occur when the market corrects from a recent overreaction.
However, contrarian trading strategies are more complex than simply betting against recent extreme market movements. Contrarian trading requires both strong analytical skills and substantial market experience to identify which stocks are likely to reverse and when.
Contrarian Trading Strategies
Contrarian trading strategies rely on a mix of quantitative analysis and a more intuitive understanding of price action.
Identifying securities where the current price is not supported by the fundamentals creates a good list of candidates for potential reversals. However, experience with reading recent price action is essential for identifying if and when a reversal will actually occur.
Therefore, contrarian trading strategies use a combination of quantitative and sentiment indicators to identify and analyze potential trades.
Most traders rely on the ability to sort a large number of securities according to various quantitative indicators, but it is their knowledge of sentiment indicators and price action that sets contrarian traders apart.
The moments of fear and greed that drive extreme price action create identifiable patterns that contrarian traders can identify and read. It is this knowledge and experience that allow contrarian traders to successfully bet against the market time after time.
Contrarian trading is an ideal approach for day traders, as the strategies involved seek out securities that are set for a quick and sharp reversal. These strategies allow day traders to identify potential reversals, and then set up trades that should last no longer than a day.
The reliance on a deep understanding of the effects of market sentiment require a substantial commitment of time and effort, but this kind of intuitive and qualitative trading is where day traders have an opportunity to profit from market participants who operate on a longer time frame.