There are many different styles to trade the Forex market, but an unorthodox trading approach like fading a move can be very profitable in the right market environment. Fading a move is where we trading against the prevailing trend.
In an uptrend or a rally, we look to sell expecting the move to fade away. Conversely, in a downtrend or a sell-off, we seek to buy with the expectation that the move will fade away and reverse.
Important: We don’t want to fade strong market trends because that’s a losing game and a receipt for disaster. Fading a trend, it’s not an easy thing to do because a trend can continue to stay in motion much longer than you might think.
What we really want to fade out are sudden or explosive moves or spikes in price that are probably unsustainable and lack the momentum to continue.
How do we fade extreme price movements safely?
Most of these spikes in price happen on an intraday basis, and moving forward I will use a Forex day trading strategy that seeks to fade spikes in price safely.
Fade a Move Conditions & Strategy
Fading requires having a contrarian approach, and many of the most prominent hedge fund managers promote themselves as being contrarian traders. So it is not that uncommon.
The primary assumption behind fading strategies is either that the trend is overbought/oversold or the move lacks momentum.
Consolidation or ranging market conditions are the ideal type of trading environment to fade spikes in price. In this regard, the first conditions we need to look for is a ranging market. Luckily, the market spends most of the time in ranging conditions which means that you’ll be able to trade with this trading strategy most of the time.
The above chart highlights the GBP/USD trading range right before the London session opening bell. You don’t have to guess in which direction the market will spike, just watch the market move naturally and only react afterward.
The second condition that needs to be satisfied in order to fade a move is that you need the spike in price to happen into an important technical level (support/resistance; swing high/low; psychological numbers).
In our case, the GBP/USD spikes down to the support level and quickly start fading away. You can either buy right away when the support level is hit or alternatively, you can use a more conservative entry strategy as follows:
- Wait for the market to start fading and pulling away from support level.
- Mark the height of the candle on your chart that started the sell-off.
- Place a buy limit order to go long once that high is broken.
It’s very important when fading a move to keep your risk contained if you want to keep losses to a minimum. So, don’t forget to use a protective stop loss to minimize the potential loss in case the trade goes wrong.
- After your order gets triggered, place your protective stop loss below the support level. You can add a buffer of 5-10 pips to protect against possible false breakouts.
- The next thing you need to establish is an ideal place to take profits, which should always be at least two or three times more than your stop loss.
Fade trading means waiting for the initial spike in price and only trade what happens after it. Usually, the first spike is the knee-jerk reaction that is designed to fool many traders into jumping into the market in the wrong direction.
Even though fade trading might seem to be risky because you’re trading against the trend it can be extremely profitable if appropriately used because the market spends most of the time consolidation and that’s where most of these spikes in price happen.