Trade With The Trend While Trading Against It: Part 1

Traders who have not added to their arsenal some form of mean-reversion trading methodology really missed a banner year (2008) for that style of trading. Traders considering making the transition from momentum and breakout strategies to mean-reversion methodologies may have a difficult time as the shift requires them to be contrarian. Taking a contrarian approach requires a transition to an alternate mindset as the trader has become psychologically accustomed to trading with the trend.

Even once this shift to contrarian mode is accomplished in the trader’s mind, taking a contrarian approach can still hit his wallet. For example, most mean-reversion approaches would have had the trader positioned long during September 2008, as the world was staring headlong at an economic maelstrom. A contrarian trader would have been positioned for a short term bounce within the context of a longer downtrend.

The best of both worlds then, or trading with the trend while trading against it, would be a system that benefits from the regular short-term swings of a mean-reverting market but is not punished by severe drawdowns when the market does not revert (swing) as quickly or as completely as the trade requires.

In Part 2 I will show a system that is contrarian and trades against the short-term trend. The system will use position-sizing and leverage to accentuate returns when trading with the intermediate trend. Similarly, position-sizing will be used to decrease drawdowns when trading against the intermediate trend. What will then be presented is a system that attempts to capture the best of both worlds: Mean-reverting, yet leveraged with the trend.