Fading trading is an opposing strategy whereby traders trade in the opposite direction to the current prevailing trend. This is a risky strategy and one that’s usually best left to professionals who have lots of experience interpreting charts and understanding technical analytics. This strategy is certainly not suitable for all.
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Fading trading: a strategy for the experienced
Traders using the Fading trading strategy are buying when prices are falling and selling when they’re rising. It seems a risky decision – and it is! The idea is that the current market will already have taken all of the information into account and that the trend direction is already well-established. The later trend stages are usually when you get your slower-reacting traders on board – and this means the trend is more likely to see a reversal.
To take an example: Fading traders might decide to buy stocks when a company informs the public and its shareholders that they are not going to meet expectations in terms of earnings results. These contrarian investors will buy for the market overreach.
Fading trading is pretty volatile as strategies go but it can generate significant profits in the short term because of this. Fading trading doesn’t need lots of analysis or complex understanding, but the risk that the trend will continue will always be there.
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The meaning of fade trade
As mentioned above, fading trading means you sell when everyone else is buying and you buy when everyone else is selling. Though this strategy can come with a chance of earning a large profit in the short term, successful traders don’t engage blindly. Traders can suffer huge losses if the trend ends up continuing rather than reversing like they hoped. However, if a trader is able to identify when something is moving in excess of the true value, he or she will use this to their advantage.
This strategy is effective mostly when the market is seeing lots of volatility as there will potentially be lots of profitable corrections. When traders use the strategy, they wait for data releases and statistics – things like sales projections or earning reports.
You can use the strategy on stocks; however, it is more suited to Forex trading because once reports are released, there are lots of fluctuations in prices.
Example of fade trading
In this example chart, you can see how risky fade trading is. Ultimately, though, it works out ok in the end.
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How to use the strategy
The majority of fading strategies may be used in only three steps:
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1. Identifying oversold or overbought conditions
Using chart patterns or technical indicators, you may identify oversold or overbought conditions. The most popular indicators are stochastics, RSI, and STO indicators. They will help you find good fading opportunities.
2. Finding signs of capitulation
Look for signs such as technical indicators that are losing steam, trend decrease volumes, or bearish candlestick patterns. This will ensure that you don’t miss a move, maximizing your profits.
3. Entering trades with take-profit and stop-loss
The third and last step to using a fading trading strategy is to set your stop-loss and take-profit orders. These are necessary to avoid slippage and are particularly useful for liquid assets. Stop-losses are often placed under resistance levels or key support. Take-profits, on the other hand, should be set based on technical indicators or mean averages.
Important risks to consider
Fading strategies go against prevalent trends. This makes them fairly risky to put in motion. To keep control of the risks and rewards of your trade, you may want to use take-profit and stop-loss orders.
Make sure that you also leave enough room between both. You don’t want to be prematurely stopped from an otherwise profitable order.
Final thoughts on fading trading
If you’re new to trading, you really should avoid trying out this strategy – there are much easier alternatives available and ones that you won’t be risking so much by using.
As always, traders need to consider their own financial situation and how tolerant they are to risk before they take on a large fade position. This strategy has a lot of risk involved and means many traders see expert advice before using it.
Risk management is vital here as is proper research and adequate risk analysis.
Here are the key takeaways about the fading trading strategy:
- When traders use the fading trading strategy, they sell when prices are increasing and they buy when prices are falling.
- Traders, for example, will often use this strategy when there is major news about world economies released.
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