Different meanings of fade
A fade is an investment strategy where one trades against the prevailing trading. Fading the market is more of a contrarian strategy which is a high risk, and only seasoned traders will most likely use it. They are aware of what they are getting themselves into, willing to go against the ordinary market wisdom. Other people say the term fade when talking about a dealer or a market maker failing to honor a published quote when another client or dealer wishes to trade. Faded quotes are not firm, and they tend to move against a client.
A fading trader sells during a price hike and buys during a decline. As we mentioned, this is a contrarian strategy that opposes the prevailing trend. A trader would do this because the market already considered all information, and the trend’s later stages are usually powered by traders who are not fast enough to react. Hence, they increase the chances of reversal in the first thrust.
In a company, the fundamentals, price action, or the combination of the two may be faded. Let us say that an investor may buy stocks even after a profit warning because they feel like the market overreact in the situation. Hence, they use the fade strategy, which is also commonly known as the contrarian strategy. Fading investors know that that strategy is volatile. However, they do so anyway because of the massive short-term gains. Risk is unavoidable, and there is always the possibility that the trend will continue, but a complicated analysis can do the trick.
Market makers also do the fade.
Market makers can also ignore an order to make a transaction at a published quote. Let us say that a better bid for a security was posted on a different exchange. The market maker may refuse to match that for the client. Instead, he offers to trade with the other market maker who provides the better price. So, that offering market maker should accept the offer and trade at the suggested price if he will not adjust the bid price.
What is the trade or fade rule?
SEC created the trade or fade rule so that the market maker should match a better bid in another market if he does not want to trade with the market maker with the better offer bid. The rule was made to avoid trade-throughs which are trades executed at a worse price than the best available price. Many did not support this rule; that’s why it later became the firm quote rule.
Can I apply fade in forex trading?
In forex, fade and economic data jive well. There is a strategy called fading economic news. Traders trade against the direction of the number released each week on the news regarding interest rates, employment data, economic activity reports, and the like. Traders who already have ample experience know that they should wait a bit after the news release before trading. Hence, the algorithmic trading models will act on the news while giving chances to regular traders to think about most of the trend as soon as the news fades. Volatility may last several hours after a news release. A wider stop will one avoid getting whipsawed out of a position.