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As my good friend and mentor Dave Landry likes to affectionately say, “We are trend-following morons.” It may sound like a put down or just self-deprecating humor, but it is true: successful traders follow the trends. However, it can be easy to mistake a market countertrend for an established new trend, so let’s talk about that today.

Spotting a new trend is not easy, and you can really get taken to the cleaners if you’re not careful. The good news is that uptrends last for quite awhile, while those nasty downtrends do not typically last too long. You need to learn to identify a new trend and not be fooled by a market countertrend. A countertrend has the appearance of a change in direction, and far too many traders get fooled by them.

How to spot a market countertrend

First, let’s talk about how to spot a new trend. I look for two things: a strong trend and extreme readings (overbought or oversold).

A strong uptrend is visible on the chart (of an index, stock, ETF, etc.). You’ll see higher highs and higher lows, and it will stay overbought for some time. You’ll also notice that indicators confirm the trend.

Downtrends have the opposite qualities. You’ll see lower highs and lower lows, along with an oversold condition. They tend to be short and volatile.

A market countertrend also displays extreme readings of overbought or oversold – but it is never confirmed.

Some traders will place trades against the current market trend, based on an anticipation that the market is going to reverse. I do like to take a contrarian stance from time to time. When the boat is full on one side, it might be time to move to the other side.

However, if these signals are short-lived – and in the moment you don’t know that – the countertrend will peter out while the prevailing trend (up or down) just continues onward. That contrarian trade you just placed is now taking a bite out of your portfolio.

So – is it a trend or a countertrend? Let’s keep this simple. Identify a trend, confirm it is a new trend, trade the trend, and stay with it UNLESS AND UNTIL you have signals to move to the opposite side of the trade.

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