Counter Trend Trading Technique

A Counter Trend Trade is often compared to standing in front of a bus and hoping you don’t get run over. This can be true if the necessary elements aren’t implemented at the time of the trade. The necessary elements are:

Money Management – Put position on in 1/3 blocks. If conditions materially change that changes original premise in which trade was made, don’t buy the remaining 2/3 and take your loss on just a 1/3 position.

Maximum Trade Size – No more than 10% should be committed to any single trade.

Use Options for Countertrend Trades – Options limit total losses to the cost of the option, but you can exit a option position at a small loss if conditions change that make getting out the best choice based on current conditions.

Buy options on underlying stocks or commodities that have a premise that makes sense. For example, many strong stocks will get hit hard by indiscriminate selling that happens in a market in steep decline. Steep declines are usually caused by some shock event like 9/11 or most recently sub-prime woes, which becomes a contagion. There will be countless opportunities in stocks or commodities that have little or nothing to do with the contagion, but become oversold or overbought in “indiscriminate selling or buying”. In a sup-prime concerned market, a long position in an insurance company like Met Life (MET), with little exposure to sub-prime is a good candidate for call options. The stock price is off 10% in the last few weeks as the market deals with the contagion caused by the sub-prime debacle. The company has increased revenue every year since 03 with matching increases in net income.

See Chart of Countertrend Trade Here

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