5 Tips for Trading During Volatile Markets
Increased volatility leads many traders to seeing an increase in
trading opportunities. The huge market swings trigger thoughts of
monumental upside, but also for potential loss especially if traders do
not take the necessary precautions. During times of volatility, traders
need to adjust their strategy to compensate for erratic market. When
trading during these market conditions, traders should follow the rules
below.
1. Be More Selective Before Placing Trades
Wanting to take advantage of all the trading opportunities that
present themselves in volatile markets, traders are tempted to place an
increase number of trades. This temptation should be avoided. It is
important to remember that in volatile times, losses are likely to be
big. Before placing a trading, assess risk tolerance
levels. Determine the level of risk that is acceptable for the trader
both psychologically and financially before placing any trades.
2. Use Less Leverage
During high market volatility, losses can be traumatic. With the
average trading range increased in volatile times traders should be
considering how leverage
will affect trades. At a one percent or even a half percent margin,
investors should be mindful of how much leverage or even the size
position being traded can affect their portfolio. In normal market
conditions, placing a 2 lot position is fine when you are looking to
make about 50-100 pips. During a more volatile time, when the potential
loss is 100-200 pips, it stops being an effective risk to reward ratio.
To compensate traders should look to taking on smaller trading
positions, in this case only one lot as opposed to the average 2 lot
position.
3. Trade with More Discipline
Traders should always follow their predetermined trading strategy
regardless of market condition. During volatile markets, this is even
more important to use that same level of restraint. Traders must adhere
to any set stops, contingency plans or risk management benchmarks
without hesitation. This will help to define how much risk is taken
should price action be uncontrollable. Without this level of discipline
and self control losses can be great.
4. Tighten Stops
Many traders are hesitant to use tighter stops in volatile markets
because they see the large swings increasing the likelihood that the
position will be taken out. Having tighter stops can also provide great
risk managers in times of extreme volatility. For example, on a EURUSD
trade, rather than setting an 80 pip stop to protect your position,
consider placing a 50-60 pip stop. This will insure the protection of
your currency position and if the stop is broken, there is a high
likelihood that the trend will continue lower and the stop took you out
before you could potentially lose more money.
The width of the stop being set does depend on the currency pair
being trading as some pairs have wider ranges. In a Yen cross like the
GBPJPY or AUDJPY, traders may be more likely to have wider stops as
their average daily range is 50% more than that of the EUR/USD. With
that said, stops during volatile market conditions should not as wide
as before. Instead of a stop 100 pips below entry, traders may consider
a 25 pip reduction and have a 75 pip stop. Below is a chart showing the
EURUSD and the GBPJPY on the same very volatile day in the forex
market. The EURUSD had an impressive range of nearly 600 pips! The
GBPJPY far dominated though with nearly a 2000 pip trading range.
5. Be Prepared
It also helps a trader to know what is causing the current spate of
volatility in the markets in order to be prepared for the unexpected.
As such, an investor can accommodate their strategy to the market
environment and not just the currency pair being traded. The first of
these considerations is accounting for emotions in a market: is fear
currently driving the market lower? Or is it buyer's mania that is
keeping the bullish tone alive? Traders' overreaction and emotion tend
to push markets to overextended targets. This fact alone creates
volatility through simple supply and demand.
Volatility can also, and more than likely will, be sparked by
economic events. In this instance, market participants may interpret
fundamental data differently and not as cut and dry as the more novice
trader. A perfect example of this is usually monthly manufacturing
reports that are released in pretty much all industrial economies. The
classic scenario has the market honed in on a particular number for the
month. However, traders young and old will sometimes wonder why the
market sold off if manufacturing showed positive growth. The answer is
simple. The market had a different interpretation and positions were
violently reshaped and shifted. These tend to create great
opportunities for some and horrible memories for others. Below is an
hourly chart of the EUR/USD during ISM Manufacturing for October 1,
2008. Here we can see the huge price gap that occurred due to market
volatility as well as the resulting trend.
Panic and erratic momentum can additionally be found in certain
market environments. Not to be confused with fear or greed, panic
selling and buying can create very choppy and relatively untradeable
markets. These conditions will lead some to flip flop their positions
while leaving others gaping at the fact that the position was right,
only to be stopped out prematurely. These two common examples will
create further panic and volatility as traders abandon their own
individual strategy for the possibility of instant profits or stoppage
revenge. As a result, a vicious cycle of volatility ensues until a
definitive market direction can be established.
The simple rules above, and a task of getting to know the current
trading environment, can empower every trader through the ranks.
Although some relate volatility with difficult and untouchable markets,
opportunities continue to remain abound in these less than attractive
conditions to those focused and fortunate.
By following these five simple steps, trading in volatile market
conditions should be a little simpler. Don't forget to adjust leverage
based on volatility, follow your trading plan, tighten your stops and
know why you are getting into a trade before you place it. |