5 Golden Rules for Trading in a Volatile Market – By One Financial
1. Use Stop Losses
Using a stop loss – a preset level at which an open trade is automatically closed – is standard good practice; this limits your downside risk and also shows trading discipline, which is paramount in developing a healthy trading account. However, when markets are incredibly volatile, you could see some slippage with the position not being able to be closed at the exact level specified. In volatile markets there is often a “gap” on the open, where an index opens substantially lower or higher than expected, perhaps by as much as 10-15%. With a normal stop loss you will get the first available price.
One Financial will provide stop loss cushions with the aim of reducing the effect of slippage on stop loss orders. The stop loss cushion has been developed to provide the client with an element of protection over such market moves. Our stop loss cushions allow for a slippage of 10 pips in the underlying market before the effects are seen on the client’s account.
It is notoriously difficult to set your stop loss at the right distance from the current traded price, but when markets are volatile, you should set your stop losses wider apart than normal. Otherwise you risk being stopped out before having made any money at all.
2. Reduce Your Trade Size
Margin is one of the biggest advantages of CFD trading and at One Financial our 1% on FX, Bullion and Indices and 3% on commodities are amongst the most competitive in the marketplace but with any margin trading you should always be aware of how much is required to keep your position in the market.
A general rule of thumb is that no single trading position should amount to risk exposure of more than 5% of your available capital. However, in volatile market conditions this kind of leverage is dangerous as any losses will be magnified even more than normal. The best market practice would be to halve your normal trading size over volatile trading conditions.
3. Limit Your Trades
Volatile markets are associated with high volumes of trading which may cause delays in execution. While online trading normally means you place a trade at the bid and offer you see on the screen, some market-makers may widen bid/offer spreads or even temporarily withdraw tradeable prices. This means that execution can be delayed and prices to execute at may not be available at all. One Financial provides fixed spreads no matter what the market conditions but in times of increased volatility it is sometimes better to limit trade execution.
4. Look to Hedge Positions
In extreme market volatility, trading one product could wipe out your trading capital. One way to limit your exposure to these kinds of risk is to trade a combination of correlated and inversely correlated products.
The strategy would limit any downside while taking advantage of volatility. An example would be to buy Gold to take advantage of safe haven buying and then to also buy dollars to hedge your Gold trade. Dollars have been the safe haven currency when times are troubled but Gold can be a more attractive alternative.
The idea of hedging positions means you use inversely related products which do the opposite to each other therefore giving the trades protection if a strategy risks going wrong.
Another approach is to simply sit out the storm on the sidelines and wait until market volatility calms down. When markets are volatile it offers an opportunity to learn faster than normal. In most cases, due to investors pulling out, an inefficient market is created with potentially more profits to be made.
5. Stick to Your Strategy
During volatile times it is easy to be shaken and diverted from your normal trading strategy but most experienced traders apply the same approach to choosing investments as they normally do.
While it’s tempting to react to the volatility, it’s incredibly difficult to predict moves in the short term, so you have to stick to your trading strategies and limit your risk exposure when times are volatile.
About One Financial
One Financial Markets is one of London’s leading online brokers, offering a range of trading platforms for FX, share, index and commodity trading. As regular contributors to financial television news including CNBC, One Financial Markets provides regular free market updates and analysis for investors and traders.