Contrary opinion is a very unique approach to predicting future price movements. By measuring not price movements, but the sentiment of market participants, contrary opinion allows a trader a deep insight to what the market can do next. Therefore, contrary opinion can be a useful element of any trend based trading strategy.
Normally we talk about either technical or fundamental analysis. In theory, contrary opinion is generally listed as an element of technical analysis. In reality, though, it can be better described as a third technique: Psychological analysis.
Technical analysis works on the premise that price movement is exclusively driven by supply and demand. A trader that can find out what drives supply and demand can predict future price movements. When we accept this premise, adding a psychological element to our trading strategy becomes a logical move, because it helps you predict what traders will do.
Contrary opinion does exactly that. By analyzing the bullishness and bearishness of market participants, contrary opinion is trying to determine future price movements.
The basic principle of contrary opinion is that when the vast majority of people agree on something, they’re usually wrong. According to contrary opinion theory, a trader should therefore try to find out whether the majority of people in the current market are bullish or bearish, and then do the exact opposite.
To determine the bearishness and bullishness of market participants, every week financial newsletter are polled. Since many traders follow the advice of these newsletters, this poll is a good indication for what most traders think about the market.
Most contrary opinion providers deliver their number as a percentage of how many people in the market they believe to be currently bullish. A value over 75 percent is considered overbought. A market top and a bearish turnaround may be impending. A value of below 25 percent is considered oversold. A market bottom and a bullish turnaround may be impending.
Some traders, however, adapt these numbers. They argue that there is a general bullish tendency in markets caused by the hope for rising prices by the general public. Therefore, they see 55 percent as the true normal value, and consider markets over 90 percent overbought and below 20 percent oversold.
To understand why this interpretation is common, think of the market in terms of supply and demand: In an uptrend, demand has to exceed supply for prices continuing to rise. When the overwhelming majority of traders are bullish, however, it is safe to assume that most traders willing to buy an asset already have bought. Therefore, there is nobody left to generate enough demand for prices to keep rising. Supply will exceed demand, and the market will turn around.
This is the basic principle of contrary opinion: In order for prices to move in a certain direction, more traders have to switch from one side of the market to the other than the other way around. If almost all traders are on one side of the market, there is only one way left for them to switch.
As a binary options trader, it is important to understand that contrary opinion works on a longer timescale than you can trade with binary options.
Still, contrary opinion can help you identify price extremes leading to market turnarounds. Combined with either another trend-based indicator, such as the momentum or the relative strength index, or combined with candlestick formations, contrary opinion can help you predict future price movements and find good trading opportunities.