Being a contrarian trader means not just following the crowd. It means being willing to break the rules when necessary!
Statistics show that the “crowd” loses close to 80% of the time position trading, and very close to 90% of the time day trading. Why would anyone want to do what all those people are doing?
So, what is it the crowd is doing? For the most part they are struggling with Fibonacci numbers, a variety of indicators—some of which are proffered as having magical qualities—reading books by authors who never made it as traders, and thrashing around with mechanical trading systems, which are said to work all the time, when it is plain as the nose on your face that such a thing is impossible.
It seems that considering the high percentage of losers in this business you are repeatedly being warned that trading isn’t all that easy, and truthfully, it's much harder than it looks.
Think about it for a minute: If trading were easy, if it were really possible to make a lot of money quickly being a trader, why would anyone want to be a plumber, or an electrician, or an engineer, or ….
It seems that many traders fall into two categories. The first category is the wild gambler, who thinks rules have no meaning and wonders why anyone would try to set them. At the other extreme is the absolute conformist who tries to exactly follow the rules, as if there were some great virtue in doing that.
Have you ever run into a system trader who will boastfully tell you how proud he is of having stuck to a system with great discipline, following it exactly until he lost all his money? Bragging about his discipline as though it had some sort of virtue to it? In reality, that kind of trader is a lemming who happily runs off the edge of a cliff only to drown in a sea of his own stupidity.
Neither extreme is the best for trading. You don’t want to be a total rule breaker and you don’t want to be a total rule follower, and for sure you don’t want to follow the crowd because the crowd is usually wrong.
As a trader, you have to find the right balance between extremes—breaking and following rules—and following or not following the crowd. It takes maturity derived from trading experience, self-examination and a solid concerted effort to act independently, and it is essential to develop this skill in both those areas.
Following the crowd is a natural human tendency. It appears that there is safety and comfort in numbers. But such a situation is certainly not true in trading. Group dynamics just don’t seem to work very well when it comes to trading the markets. From time to time there have been partnerships that worked, but they are few and far between. In all the years I’ve been in the markets, I’ve known only one partnership that worked, and it was structured in such a way that one person did all the research and the other person made the trading decisions and performed the actual trading. Nevertheless, people somehow feel secure when they follow the crowd.
I grant you that not everyone follows the crowd in the same way or to the same degree, but it is the contrarian who views the crowd to see what they are doing, and then does the opposite. In my own case, I am contrarian in the following way: When everyone is hot to trade the e-minis, I avoid them, preferring to trade where the crowd is not looking. I find lots of great opportunities by looking around, being eclectic and discovering trades that meet my criteria for profit potential, tradability, and personal comfort.
I tend to be adaptive most of the time, adapting my trading management to setups offering me high potential for successful trades.
When the mob is losing their shirts in the e-mini, I am trading options with at least a 75% chance of producing a winner. When the crowd is thrashing around trying to daytrade forex, I am trading spreads with at least an 80% chance of bringing home a profit. I am not averse to trading anything, anywhere. I trade Exchange Traded Funds and individual shares. Why not? Some of them have excellent potential.
I find that instead of searching for opportunity, most of the people losing money in the markets are looking for rules to follow, indicators to dream up, and systems to pursue. The crowd spends an inordinate amount of time backtesting.
If you are going to trade, it is time to matriculate to the real world of trading. We are no longer in school or on the job where to be successful, it was critical to follow the rules and it might have been essential to protect your self-interests and stay within the parameters of acceptable behavior. In school and on the job it was important to develop a clear sense of individual values so that you could be somewhat self-sufficient within the boundaries of the group.
The contrarian trader is eclectic to the extent that he or she can follow the crowd when it seems right, but go his or her own way when it's necessary to protect self-interests. What the contrarian trader does that others will not or cannot bring themselves to do, is to go the opposite way when it seems that everyone else is going the same way.
Time and again history has proven that when everyone is buying and a market seemingly will never stop going up, that is the time to sell. And when something has sold down to the point where no one wants it and the media are all screaming out that it is the end for this market then it is time to take a trade the opposite way from the crowd, and become a buyer—that is what it means to be a true contrarian.
Contrarian traders heed the frequent warnings about the pitfalls of following the crowd. When no one wanted gold and the media screamed about how gold was a relic whose time had passed into history, it was buying time. When everyone was selling the Nasdaq and the media screamed “end of the world for tech stocks” it was again time to buy.
When you read in the media that a market it too volatile and too dangerous for trading and they flash warnings for their readers to stay out, that is the time to be looking to be an option seller. Options sellers make money by selling volatility. If you are a contrarian option trader, you aren't looking for safe markets. You are looking for volatility, reasonable risk, and a good chance for making a big profit. Most of the time, it means going your own way—the way that is opposite the mob.
Being a contrarian requires thinking like a contrarian, guessing what the crowd will do next, and anticipating how the movement of the crowd can benefit your trading.
When virtually everyone has taken the position that the market is headed in a particular direction, who is going to be left to push the trend further? It is precisely then that a countertrend begins and moves the market in the direction of the contrarian trade. The challenge is predicting when that turning point will occur, anticipating it, and developing a trading plan to capitalize on it.