Fading an overreactionTrading against a move that went too far.
A fade trades against a move that went too far, too fast. 3 trades from a live journal show when a rally built on unconfirmed headlines is worth fading, and why being right too early still loses.
When price gets there too fast
The next entries from the live journal go against the crowd. The crowd may even have the direction right. The trouble is that price got there too fast.
In one stretch, headlines about trade deals sent risk appetite soaring. On risk-on days like these, investors sell safe havens such as the yen and the Swiss franc, so pairs that buy another currency against the yen shot higher, CAD/JPY and NZD/JPY among them.
Built on hope
Look closer at what drove the move. A US-UK trade deal was confirmed, and optimism grew about a possible US-China agreement. The first was real. The second, the big one, rested on unconfirmed reports while the talks were actually at a standstill.
So the trade was a tactical fade. A fade means trading against a move you think has gone too far. Once CAD/JPY reached overbought territory, stretched well above its normal range, a short was opened with the reversal strategy, aiming for a pullback. Short means you sell the pair, so you make money if it falls.
NZD/JPY got the same treatment. The market had priced in optimism quickly on limited progress, and sentiment could easily reverse if the headlines stalled.
What makes a fade different
2 things set a fade apart from a normal trade. First, it is short term. The broader view on the yen stayed weakly bearish, and the fade did not change it. The short on CAD/JPY was only a bet on a correction in a rally that had run too far.
Second, it needs a clear reason why the move is fragile. Here that was optimism priced in too quickly, with little real substance behind it and headlines that could easily stall. Without such a reason, selling a big move means standing in front of a market that may have good grounds to keep going.
Right, but too early
Fades don’t always work. The same idea on USD/CHF was right about the direction. The confirmed US-UK deal had lifted risk appetite and pushed down the Swiss franc, another safe haven, so USD/CHF surged. The view was that the market had reacted too quickly and that hopes for a US-China deal ran ahead of the facts.
Price kept climbing first. It hit the stop-loss, the exit you set in advance to cap your loss, and only after that did the reversal come. The direction was right, and the trade was still a loss.
Being right too early is still a loss.
Fade only the thin stories
So keep fades rule based. Many big moves have solid reasons behind them and can run much further than a short can survive. Fade only the ones where the story is thin, such as a rally on unconfirmed reports while the real talks are stuck.
Then let the chart confirm it. Wait until the pair is overbought, take the trade only on a valid trigger from your reversal rules and set the stop before you enter. Aim for a pullback, not a new trend.
Mistakes to avoid
- Fading every big move. A rally with real substance behind it can keep going much longer than a short can survive.
- Fading before the pair is stretched. Without overbought levels and a valid trigger, you are guessing where the top is.
In short
- Trade-deal headlines sent CAD/JPY and NZD/JPY sharply higher, but the big deal rested on unconfirmed reports while the talks were stuck.
- A fade is short term: once the pair is overbought, the reversal strategy sells for a pullback, and the bigger view on the yen stays the same.
- The same idea on USD/CHF hit its stop before the reversal came, so fade only thin stories, with overbought levels, a valid trigger and a stop.
Key terms
- Fade
- Trading against a move you think has gone too far, for example selling after an overreaction to a headline.
- Overbought and oversold
- When price has risen (or fallen) so far, so fast, that a pullback becomes likely. Not a signal on its own.
- Risk-on and risk-off
- Risk-on: investors feel confident and buy stocks and higher-yielding currencies. Risk-off: they get nervous and move into safe havens.
- Safe haven
- An asset investors buy when they are scared, such as the Japanese yen, the Swiss franc, gold or US government bonds.
- Pullback
- A short move back against the main direction before price carries on. Waiting for one often gives a better entry than chasing the move.
- Stop-loss
- An order that closes your trade at a set price to limit the loss. It belongs where your idea is proven wrong, not at a random distance.