I guess anyone who has been in forex more than 5 minute has learned that “90% of all forex traders fail”. If most traders in the market fail, then taking decisions against most traders should provide an edge, since the large portion of retail traders tends to always be wrong, trading against them may seem to warrant some profitability. However the issue is not so simple as designing an actual mechanical strategy based on this behavior is a very difficult task, particularly because knowing the “real-time positioning” of a large amount of retail traders is hard. On today’s post I will talk about a possible solution to this problem as well as a strategy I designed based on this solution. It will certainly not work in the short term time frames but it may provide a statistical edge in the following of long term trends if in fact most traders tend to be on the “wrong side” of trades.
The first thing we need to understand if we want to take positions against the masses is how contrarian trading works and how currency pair rates change. Whenever a person takes a long or a short position it is done so with the expectancy that more traders in the future will do the same thing at worse prices. If for example you go long EUR/USD at 1.5040 it means that you are expecting other traders to go long at levels above this, to drive prices to even higher values. Retail traders tend to get into positions at prices that are not attractive for major players which are effectively the main drivers of market price changes. When a majority of retail traders are positioned in short or long positions the market will turn against them to favor the least possible amount of traders (the 10% or less profitable).
It would therefore be possible to develop a system to profit from this behavior if we could have access to real-time positioning of retail traders. When 90% of retail traders hold a certain type of position then the market is bound to move the other way until at least equilibrium between positioning is reached (50-50) or until a new extreme is reached towards the opposite direction. So if 90% of retail traders are long GBP/USD then the market will turn against them until at least 50% are long and 50% are short, then it may take it to an opposite extreme (10% long, 90% short) or return it to the original one for a second “swing”.
Until recently we had no tool that could estimate the positioning of a “decent amount” of retail traders but now – with the help of MyFxBook – there is a tool available to solve this problem. This website has released a new feature – called Outlook – which shows community positioning, representing the positions of more than 20 thousand live retail trading accounts. During the past few days I have experimented with this feature a little bit and I have already achieved several profitable positions on major currency pairs. For example this tool achieved an extreme on the EUR/USD towards the short-side this Monday, time in which I went long on the currency achieving an almost 300 pip profitable swing. Since then positioning has been shifting towards the long side and it is now close to a 50-50% positioning, meaning that it is now time to exit the position.
Of course, such a system is bound to be difficult to evaluate since their is no previous historical data for this “outlook” tool and therefore future performance is by all means unknown and obviously due to this reason its trading should be evaluated on a demo or very small live account for at least a couple of years so that some idea of profit and draw down targets can be drawn. However the possibilities are very interesting, showing us that the fact that most retail traders fail may in itself be exploited as a market inefficiency. This strategy is based on a whole new set of information which is not available from traditional technical analysis, the net positioning of retail traders.
Another great advantage of using this tool against other traditional contrarian indicators as the COT is that this information is available in real time and not just released weekly like these other options. However this information also has the disadvantage of containing only data about a reduced group of retail traders and none about major player positioning which is available through other positioning indicators. As a matter of fact it might be interesting to analyze mechanical strategies developed against the COT to judge their long term performance based on the available weekly historical data of this fundamental indicator.
In the end this new “outlook” tool provides an interesting source of information which could be used – or at least tested – for the development of contrarian trading strategies. If you would like to learn more about my work and how you too can develop your own long term profitable systems please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach automated trading in general . I hope you enjoyed this article ! :o)