- Breakouts are exciting, but trading them is not always feasible.
- Trading within a range is more common, but offers fewer pips.
- Using overbought and oversold conditions can combine both worlds.
A user has asked: "I always have the sentence „the trend is ur friend“ in my head. You described the idea of mean-reversion. Does that mean to trade overbought and oversold situations (of any indicator)? And is it really a profitable way of trading?"
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When a financial asset is trending in a clear direction, it is better to trade with that trend than try to catch the occasional counter-trend. There is a better chance to make money when trading with the bigger move than with a smaller one.
When an asset is floating within a clear and limited range, traders tend to look for the big breakout, either to the upside – buy above the top of the range and sell even higher – or to the downside, by looking for the fall out of the range, selling the asset and covering even lower.
However, when an asset is trading in a range, it is often easier to trade that range. If the pair slides to the bottom, buy it, and wait for it to return to the middle of the range. If it is moving higher, sell it, and cover when that asset drifts back down to the middle.
While there are fewer pips in this method, it is often the better strategy when it is unclear assets where the price is going. Moreover, there are often many false breaks – looking at you EUR/USD – and therefore, it is often hard trading a breakout.
Now, what about overbought and oversold conditions? When a currency pair – or any other asset – trades in a wide range, it can hit overbought conditions when surging from the bottom of the range to the top. In that scenario, the case for selling the pair toward the middle of the range makes even more sense.
The same goes for the other way around – an extreme fall from the top to the bottom may send the asset to oversold conditions, thus adding to the case of making mean-reversion trading toward the middle.
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Editors’ Picks
EUR/USD holds lower ground near 1.1850 ahead of EU/ US data
EUR/USD remains in the negative territory for the fourth successive session, trading around 1.1850 in European trading on Friday. A broadly cautious market environment paired with modest US Dollar demand undermines the pair ahead of the Eurozone GDP second estimate and the critical US CPI data.
GBP/USD keeps losses around 1.3600, awaits US CPI for fresh impetus
GBP/USD holds moderate losses at around 1.3600 in the European session on Friday, though it lacks bearish conviction. The US Dollar remains supported amid softer risk tone and ahead of the US consumer inflation figures due later in the NA session on Friday.
USD/JPY rebounds above 153.00 ahead of US inflation data
USD/JPY stages a comeback and regains 153.00 in the Asian session, snapping a four-day losing streak amid some repositioning ahead of the US CPI report. However, expectations that Japan's PM Sanae Takaichi could be more fiscally responsible, along with bets that the BoJ will stick to its policy normalization path and the risk-off mood, could support the safe-haven Japanese Yen, capping the pair's upside.
Editors’ Picks
EUR/USD holds lower ground near 1.1850 ahead of EU/ US data
EUR/USD remains in the negative territory for the fourth successive session, trading around 1.1850 in European trading on Friday. A broadly cautious market environment paired with modest US Dollar demand undermines the pair ahead of the Eurozone GDP second estimate and the critical US CPI data.
GBP/USD keeps losses around 1.3600, awaits US CPI for fresh impetus
GBP/USD holds moderate losses at around 1.3600 in the European session on Friday, though it lacks bearish conviction. The US Dollar remains supported amid softer risk tone and ahead of the US consumer inflation figures due later in the NA session on Friday.
Gold trims intraday gains to $5,000 as US inflation data loom
Gold retreats from the vicinity of the $5,000 psychological mark, though sticks to its modest intraday gains heading into the European session. Traders now look forward to the release of the US consumer inflation figures for more cues about the Fed policy path. The outlook will play a key role in influencing the near-term US Dollar price dynamics and provide some meaningful impetus to the non-yielding bullion.
US CPI data set to show modest inflation cooling as markets price in a more hawkish Fed
The US Bureau of Labor Statistics will publish January’s Consumer Price Index data on Friday, delayed by the brief and partial United States government shutdown. The report is expected to show that inflationary pressures eased modestly but also remained above the Federal Reserve’s 2% target.
A tale of two labour markets: Headline strength masks underlying weakness
Undoubtedly, yesterday’s delayed US January jobs report delivered a strong headline – one that surpassed most estimates. However, optimism quickly faded amid sobering benchmark revisions.
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