Trading in a Volatile Market
At times, the Forex markets can become extraordinarily volatile. For that matter, any market can, depending on what has been going on. You can be in a nice uptrend, only to have a headline crossed the wires that turn things back around to knock you down, causing massive losses. In this article, I’ll look at the special challenges when it comes to trading in a volatile market.
First things first: manage your risk
The first thing that you need to pay attention to its risk. For that matter, it should be the first thing that you pay attention to in any trading environment. Ultimately, if you don’t manage your risk, you will go broke trading and lose all your trading capital. That’s always going to be the first thing that you should think of when putting money to work.
If situations continue to become very volatile, then you are looking at a situation where protecting your risk becomes even more important, and therefore you should look into your trade size. For myself, one of the most effective ways I have found to protect trading capital in a volatile situation is to cut the position down. In other words, if you typically trade 0.5 lots, then you may wish to trade 0.25 lots because of the inherent risk in a market that can move very rapidly.
Understand that professional traders will be forced by risk managers to cut down their position size as well. For that matter, professional traders tend to trade with much less leverage than the retail trader. It’s not uncommon at all to see a professional trader using 1:7 leverage, instead of the 1:200 that a lot of retail traders will use. Part of this is because the professional trader has a larger account, sometimes going into the millions of dollars depending on the situation and/or bank they are working for. When you make a 5% gain, it means much more in that account than it does in a $2000 account.
The trend becomes even more important
When trading in a volatile market, the overall trend becomes much more important. While volatile markets typically denote some type of trend change, the reality is that the longer-term trend tends to be what the market pays attention to overall. Because of this, if you are in a volatile market you may wish to only trade in the direction of the longer-term trend, meaning that you need to sit on your hands occasionally. I think at this point, it’s likely that the best thing to do is wait for the larger money to come in and push in the right direction, as well as keeping your trade position smaller, because of the potential of losses.
Typically, a lot of volatility comes at the hands of fear and possible occasional headlines, but when you look at a Forex chart, most of the time they trend for years. There are times when things go back and forth rather drastically, but overall, I think that most of these moves end up being value propositions for those willing to jump into the fire. That doesn’t mean you should do so briskly, it just means that the longer-term trend still holds true for the most part. You should however have a “line in the sand” when it comes to the longer-term trend and recognize that a break down below or above that line represents a change.
Once the longer-term trend changes, it changes the overall strategy when it comes to trading, but this as a general rule should be something that is based upon weekly, if not monthly charts. While this could cause a lot of short-term pain, the reality is that eventually the longer-term trend reasserts itself most of the time.
Sometimes, it’s better to sit on the sidelines
Unless there’s some type of major geopolitical or global event, the reality is that you can almost always find a pair to trade that’s much less volatile. Ultimately, a lot of traders get married to a particular currency pair, not understanding that they all operate the same. In other words, if you are typically a trader of the EUR/USD pair, then you should perhaps look to another market if it has become too volatile. Exactly what is stopping you from changing the pair and start using the EUR/CHF pair? Just step away from the overly volatile currency pair, because it’s not worth it. At the end of the day you are simply trying to profit, not become a genius on a particular currency.
Higher time frames
Another thing that you can do when things get a bit volatile is simply go to higher time frames, which will naturally make you cut down your position size. For example, you may typically trade the hourly chart and risk something along the lines of 50 pips on average. However, if you are forced to trade the daily chart, you may need to risk 120 pips on average. You still want to risk the same amount of capital per trade, so you will have to start out with a smaller position in let the market work its magic over time. This forces you to focus on the big picture and pay attention to the overall attitude of the market instead of the day-to-day noise.
Turn off the news
You should be cautious about paying too much attention to headlines, because they don’t matter. What matters is where prices going, not what some politician in Brussels says, Donald Trump says, or anybody else. Markets are truth, and truth can be found in pricing. Beyond that, when things get too volatile you will find poor analysis much more likely, as even the best analysis can become less useful after just a few hours. You need to look at the big picture in these situations, and simply relax.