Fading is a form of trading which aims to put on short-term positions and take profits after small price changes. It is similar to Scalping but looks to make profits from trading the price movements that are in the opposite direction to the general price movement.
Trading a Fading strategy involves buying and selling when price action temporarily reverses to go against the general market direction. Even if a particular instrument looks to be having an ‘up’ day, there will be opportunities to sell short and catch short-term price movements to the downside. The reverse would apply in a falling market where price is supported at various levels and for a short period when buyers outnumber sellers. It takes advantage of the fact that markets don’t tend to move in a straight line.
Fading can be applied to news events that are stock specific (company announcements) or more general such as the release of economic data. Any significant market move that follows a news release might be seen as an over-reaction, particularly if price action triggers a large number of stop losses that traders had set at a certain level. Hitting stop losses can exacerbate the price move until it is considered to have over-shot. Trading a Fading strategy implies there is now an opportunity to make profits out of the process where price realigns itself to where fundamental analysis suggests it really should be.
In the chart below the long-term trend is upwards, but there are still opportunities to make profits from short-term price action to the downside.
IG Index 20181113
As with Scalping, the usual Risk Factors apply, especially Gapping Risk.
Getting ‘stuck’ in a Fade Trade can be costly. Having a position that is against the general price direction means you might be in the unhappy position of trying to minimize losses rather than maximize gains. For that reason, the setting of stop losses at appropriate levels is particularly important.
As with Scalping trades, You’ll want to use a Trading Platform that has reliable, high-speed connectivity to your own place of trading. You don’t want to suffer periods of being unable to connect to your broker to execute. It’s, therefore, sound advice to try Fading using a broker’s Demo account and monitor the reliability and speed of the connection.
Fading is a Contrarian style of trading so practicing with a Demo account will also allow you to analyze if it is a good personal fit for you. Again, it might even be that one platform is better for you for Fading one instrument and another better for Fading something else, so research the pros and cons of the respective broker platforms.
Fading can be applied to any instrument or market with the right kind of trading volumes and price volatility. As you are taking a contrarian approach, it can be beneficial to trade an instrument that has some, but not too much price volatility as spikes in the general direction of traffic might hit your stop losses.
It is also important to trade instruments that have tight bid/offer Spreads, so research how they compare across brokers that you can access.
Bulls and Bears
Upward and downward market moves tend to be different in nature. Upward markets are associated with more gradual price movement; it’s perceived that this is what they naturally do. Downward markets tend to be more dramatic and sell-offs can look like prices are falling off the edge of a cliff. The different type of market momentum means that Fading in Bullish and Bearish markets is quite a different experience. Particular risks are involved with Fading in a bearish market. Hence the adage warning it’s not a good idea to try and catch a falling knife.
Fading is not for the risk-averse. It’s a contrarian trading strategy and is fast-paced. Despite the risks involved the distinctive approach does offer clear guidelines regarding risk management and it appeals to a lot of traders.