Head-Fake Trade

What Is a Head-Fake Trade?

A head-fake trade is the point at which a security's price takes action in one bearing, however at that point switches course and moves the other way. The head-fake trade gets its name from a strategy usually utilized by a ball or football player to mislead the resistance, by leading with their head to imagine that they are moving in one bearing however at that point move the other way. The head-fake trade happens most often at key breakout points, for example, major support or resistance levels, or closely watched moving averages like the 50-day or 200-day simple moving average (SMA).

Understanding a Head-Fake Trade

Consider a situation where a major market index has made new highs in the midst of decaying economic fundamentals. Traders who are hoping to short the index will closely monitor critical technical levels to evaluate whether the advance is beginning to break down. Assume the index advance slows down and starts to drift lower, trading below a key short-term moving average. The bears could rush in right now, in light of their trading view that the index decline has started, yet assuming the index subsequently switches course and heads higher, this would be a classic head-fake trade.

Antagonists frequently try to profit from head-fake trades, since their trading philosophy embraces an eagerness to conflict with the crowd. They contend that institutional traders push a security's price through closely watched support/resistance areas to track down extra liquidity to take care of bigger requests at a better price for their clients, especially in the foreign exchange market, which doesn't have a centralized regulator.

Traders and investors who fall for a head-fake trade can cause huge losses as they frequently happen before the beginning of a major trend the other way. Adherence to severe stop-loss limits in such cases assists with limiting risk.

The Head-Fake Trade and Breakouts

An initial breakout is normally trailed by some level of pullback. As price remembers to the original breakout level or to some degree further, the trader is left to determine whether the pullback is the beginning of a head fake — a false breakout — or whether it is transitory, and the market will before long go on toward the breakout. In the last option case, the pullback might introduce one more opportunity to enter a breakout move.

Flash Crash Head-Fake Trade

The record bull market that started in March 2009 has created many head-fake trades throughout the last decade. Maybe the most popular model was the "Flash Crash" of May 6, 2010, in which the Dow Jones Industrial Average (DJIA) plunged very nearly 1,000 points in no time in intra-day trading before deleting the greater part of that loss by the close. Traders who put on long-term bearish wagers on U.S. equity indices, in light of the view that the "Flash Crash" forecasted a new bear market, experienced the pain of seeing these indices proceed to record highs in subsequent years.

Head-Fake Trade Practical Example

The PayPal Holdings Inc. share price organized a reading material head-fake trade on June 3, 2019, plunging below both the 50-day SMA and May 13 swing low — a key support area. The stock's price revitalized 3% on the accompanying trading day to close back over the support area, providing the primary insight of a potential head-fake trade. PayPal shares kept on moving higher in subsequent trading sessions, with the head-fake trade affirming on June 10, when price closed over the previous swing high.

Highlights

• Head-fake trades happen most often at key breakout points, for example, major support or resistance levels, or closely watched moving averages.
• Head-fake trade can lead to critical losses as they frequently happen before the beginning of a major trend the other way.
• A head-fake trade moves in a single bearing, however at that point switches course and moves the other way.