As cryptocurrency traders we’re constantly dealing with probabilities and based on them, we end up assessing where is the market headed and what is the right way to take advantage of price movements. Today we would like to talk about having a contrarian approach, when is the right time to use it, and what are some of the downsides associated with it.
# What is a contrarian approach?
A contrarian approach occurs when we choose to trade the market in the opposite direction of the dominant trend. It generally happens after a very impulsive move, when valuations are overstretched and a reversion to the mean is the most likely outcome. Regardless of the crypto allocation or risk tolerance, sooner or later we’re faced with the decision to take a counter-trend trade.
The market can’t move in a certain direction indefinitely and all trends eventually break, leading to impulsive moves in the opposite direction. It gets more difficult to take advantage of such conditions in the crypto market, and that has to do with some particularities like speculation and emotional trading.
# Speculation and emotional behavior
We already know that it is difficult to calculate the exact valuation of a cryptocurrency, which is why the entire market has a speculative nature and most of the market participants are heavily influenced by emotions, rather than the effect of changing underlying fundamentals. This had led to situations where valuations moved impulsively in any given direction, only to start a strong opposite move afterward.
Taking advantage of these situations will require accurate timing, emotional regulation, a well-established set of rules, and the proper risk management system that will reduce losses and leverage profits. But as with any other trading approach, having a contrarian mindset does come with several downsides.
# Be aware of the downsides
Regardless if you are using a centralized or decentralized exchange, it is important to consider that “markets can remain irrational more than you can remain solvent”. This means that taking a contrarian trade at the wrong moment could result in fast and large losses, in case the market continues in the same direction.
At the same time, it could take longer until the reversal will unfold, testing your patience and confidence in the process. Anyways, with the right methodology and the proper training, taking the other side of the market at the right time can result in optimal valuations and increased profit potential.