What is a head-fake trade?
A head-fake transaction happens when a security’s price initially swings one way, then the other. Basketball and football players employ the head-fake trade to mislead opponents by leading with their heads in one direction but shifting in the other. Breakout marks like significant support or resistance levels or moving averages like the 50-day or 200-day SMA are common in the head-fake trade.
Understanding Head-Fake Trades
Imagine a significant stock index reaching new highs despite weakening economic fundamentals. Short-selling traders will watch vital technical levels to see if the index is reversing. Suppose the index gain pauses and falls below a major short-term moving average. Given their trading opinion that the index has begun to deteriorate, bears may rush in. A head-fake trade would occur if the index reversed course and rose.
Contrarians aim to benefit from head-fake trades because they want to go against the majority. Institutional traders allegedly manipulate prices by utilizing closely monitored support and resistance regions to secure liquidity for larger orders at better prices for their customers.
Head-fake transactions sometimes occur before a prominent trend in the other direction, resulting in significant losses for traders and investors. Following stop-loss orders in these situations is crucial to strictly reducing risk.
The Head-Fake Trade and Breakouts
Initial breakouts often result in some retreat. As the price returns to the breakout level or below, traders must decide if the pullback is a head fake or a brief, significant trend reversal. The retreat may offer another chance to break through at a better price in the latter situation.
Head-Fake Trade Example
The US dollar had a big winning run against all but a few currencies in 2022. The chart below shows that USD/HUF is on a long-term uptrend (USD strengthening/HUF falling). The dominant ascending channel contains all pullbacks except the red oval. After falling below the intraday uptrend support line, the price recovered before the conclusion of the day.
A typical countertrend head-fake pattern If one traded based on the break of trendline support, they would have discovered by day’s end that it was a head-fake price action. Tight stops or the USD-HUF pair finishing back in the dominating up channel would have alerted traders to this head fake. The fact that nothing fresh in fundamentals had changed the USD’s base for strength reaffirmed this.
How Can I Tell If the Price Is Moving Forward or Just a Head Fake?
Head-fake deals ordinarily last an hour or a day. A head-fake move occurs when the price move coincides with a technical break and then regains it. Keeping stop-loss orders tight after a price break is critical to avoid a head fake and miss the probable return of the former trend.
Head-Fake Price Moves: Why?
Head-fake moves usually test technical support or resistance, such as trendline support in an uptrend or significant moving averages. Tested technical levels often include buy-sell stop-loss orders. Stop-loss orders may create momentary buying and selling pressure if prices test or break these levels. The market may have performed a head fake or false break if the technical level is quickly recaptured (hours for day traders, days for longer-term traders).
What Should I Risk on a Possible Head Fake Move?
Since head fakes are countertrends, you need tight stop losses. Due to the uncertainty of a head-fake set-up, a quarter to a half of your regular posture is prudent and appropriate. That way, you’re investing a tiny amount of your risk capital in the breakout trade and using tight stop-loss orders to limit losses.
Bottom Line
A technical head fake is a false breakout. For instance, the current price trend is higher, but a head fake happens when a fall below crucial support surprises the market, leading to outsized swings on the breach of that technical level. Head-fake price action is typical in markets and indicates a countertrend breakout at a critical technical level.
How long the critical price level breach lasts is crucial to judging if it’s a breakout or a head-fake. Technical stop-loss orders often drive buying and selling around essential price points. After stop-loss buying and selling, there may be no news to support the break. However, new information may have caused a countertrend movement, not a head-fake. It’s important to be alert to any new news that might lead to a countertrend move or breakthrough. The breakout may be a head fake if there is none.
Conclusion
- A head-fake trade initially swings against the trend but then the opposite way, aligning with the general trend.
- Breakout spots like ample support, resistance levels, or highly followed moving averages are typical for head-fake trades.
- Stop-loss selling or buying at these levels generally causes head-fake trades.
- Head-fake transactions sometimes precede dramatic trend reversals, resulting in significant losses.
