When trying to come up with your FX trading plan, should you trade with the herd or be more of a contrarian?
Within the stock trading universe, one of the most commonly spouted bits of rhetoric is to “never follow the herd.” – the likes of Warren Buffet and Jim Slater have always warned their followers against simply following the masses when engineering their stock portfolios. They often also champion the concept of being a contrarian investor – choosing stocks while they are low and good value, and selling to the herd later on.
While you can immediately appreciate the wisdom of this when applied to equity markets, FX traders be warned – it can actually be far safer and more consistent to run with the herd, rather than trying to pick currency tops and bottoms…
The Equity Herd Mentality Becomes “The Trend Is Your Friend” In FX
One mans herd mentality is another mans trend (and friend). Within the context of FX trading, it’s absolutely essential for traders to be able to identify trends and ride some portion of that trend profitably. This is in effect following the herd – only pulling away in time before a group of lions come to peck away at the weak and unaware.
It’s very tricky being a contrarian as an FX trader. The currency markets just don’t lay their stalls out in a way that allows traders to buy value and wait for the coming reversal. In fact, taking a contrarian view when trading FX is liable to get your trading capital utterly bashed. FX price currency can defy fundamentals for long periods of time – so even if all the fundamentals point to a reversal, your stop loss will often be hit well before even the slightest hint of a turnaround comes about. Good FX trading must always understand and go with the trend.
Trading FX In A Herd Like Way – Tips
- Get To Grips With The Right Trend Indicators. Trading with the herd will mean applying a tight but potent arsenal of indicators which will help you to pin point trend direction and strength. Moving average crossovers for instance can assist traders in pin pointing new trend formations. Other indicators such as the Relative Strength Index and the Stochastic can then help you understand the momentum of the trend. They can provide insight as to how strong the trend is, and pin point instances where trends may be breathing their last.
- Prepare Your Exit Well In Advance. Good FX traders will plan their potential exits well in advance. Trading in a herd like way can be seemingly quite rosy while all traders are riding on the back of a smiling trend. However, trends can reverse quite rapidly within currency trading, and are liable to crush those traders who don’t hop off in a timely fashion. There are many exit strategies that herd traders can apply to close out their positions profitably.
- Place Common Sense Stop Losses. When trading the slope of a trend, consider not only placing stop losses to protect against loss, but trailing stops to lock in a payday should the trend unexpectedly reverse on.
For FX traders, there is often safety and comfort to be found within the herd. Placing harmonized positions with droves of other traders should be a profitable course of action – after all the trend is your friend, especially when you’re riding it like a revved up Porsche. But as you’re zooming off into the distance with the top down just keep in mind that like all good things, even trends must come to an end.