Occasionally price is able to accelerate further than any Forex trader might expect. In these cases, the price has a strong impulse or thrust and it keeps extending to new extremes. Although catching such an impulsive trade is great, what does a trader do when they missed the gravy train?
Traders could attempt to trade to the opposite direction. The probability of price moving in the same direction eventually decreases and a counter momentum opportunity arises. But when? And how does an FX trader enter such a trade?
FADING THE MOMENTUM
Usually speaking I am an advocate of trading with the momentum and I attempt to enter such a trade either at the breakout itself or shortly after a breakout. In certain cases entering a trade when there is a high chance that momentum is fading could be equally lucrative.
In these cases the chances of a bounce (short), counter momentum (long) or reversal (very long) occurring are high because the original momentum just has to stop at one point or another: the currency cannot push into one direction forever without a stop. The danger of these setups is that traders often anticipate the turning moment too soon.
Usually, the 2 following scenarios occur after the momentum dies out:
- Price moves slow and tedious, which is a sign of flag or wedge. In this case ‘fading the momentum’ traders want to exit their counter momentum trade because a new momentum in the same direction could occur at any second;
- Price has a similar momentum but then to the opposite side. This is the best scenario for the ‘fading the momentum’ trader.
There are methods how Forex traders can improve their odds of catching a bounce or counter momentum:
- Check whether the previous momentum was against the trend because then there is a higher chance that a thrust will occur to the opposite side (be more cautious when momentum is with the trend!);
- Use candle stick patterns to identify rounding formations;
- Use an oscillator to have an idea when price has divergence or otherwise has overextended;
- Identify support and resistance zones nearby which are strong enough not to break.
IN THE MARKET, FOR EXAMPLE...
In a past trading day, the market had such a counter trend momentum on several pairs such as the EURUSD, GBPUSD, AUDUSD and USDJPY and all indeed continued with the USD strength – as expected.
This market offered similar opportunities but on different currency pairs. At one time, GBPNZD, for instance, broke a channel to the downside (red lines). However, the breakout occurred then the RSI already was near an oversold value (dark red circle) and hence a bounce back up has occurred in the meantime.
The downtrend momentum could continue as soon as this upside retracement is finished so I am keeping a close eye on 4-hour candle stick patterns at the broken trend line (up to the top) for potential shorts.
The same thing could be said for the GBPCAD, which offers trade setups to both directions: a bounce back up and then a bounce back down.
Taking the ‘fading the momentum’ trade is an option when either trading the breakout or trading with the momentum is too late. Just be cautious with trading against a bigger trend or when chart patterns emerge: a market exit at about break even is often the best place to exit. Here is another article on forex trading advice and trade example.
Do you sometimes take these trades?
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