Forex trading is popular the world over. There is something captivating about sitting down at a computer and being able to engage a financial market. So, if you have an interest in trading the forex markets, then this how-to might help you understand the unique market we are currently in.
Volatility as a Market Requirement
While a prerequisite to making a profit on the market is that the market is volatile, so you can sell and buy at different prices, trading exceptionally volatile markets can bring a trader’s ruin. And it is this exceptional time that we are in now.
Trading in volatile markets such as the one we’re experiencing in today’s markets can be quite scary. These days we often see dramatic swings in price action. Such swings are indicative of market participant’s uncertainty about what the future holds.
Thus far in the Trump presidency, we have seen several such instances that affect the US Dollar. Instances, where there have been major fluctuations in the market volatility as news that is not already factored into the price, is released.
Understanding Volatility
It’s important to understand what’s causing volatility in the markets, and how that volatility is going to impact the currencies you are trading. A volatile market can often lead to a sudden change in trend that sustains itself and adds momentum in a singular direction.
As an example, the US dollar has weakened against the major counterparts since the beginning of the year. A sell-off was spurred on by the ongoing US-China trade war rhetoric between the two leaders. This language and lack of resolution have had a significant effect on the financial markets.
Because of these announcements of trade wars, the effect will be that we’re more likely to see disproportionately larger moves in the US market and China market compared to some other markets.
Different assets have different risks associated with them, which is the reason why the US stock market has seen big moves to the downside as the equity market is perceived as a riskier asset.
How to Trade Volatile Markets
The major catalysts for higher volatility are the release of major economic news, geopolitical risks, and market uncertainty. Plus, anything else that is related to risk. If the markets do not already factor in potential risk, a particular incident poses a greater threat to disrupt the market volatility.
For novice traders, the best course of action might be to stand aside in times of high volatility because volatility breeds high emotions. If you’re not used risking your funds in this type of environment you have higher chances of losing your money.
These are the four major rules you need to follow if you want to trade volatile markets safely:
- Keep your risk under control.
- Alter your usual position size.
- Follow the short-term chart.
- Be reactive, not predictive.
Keep Your Risk under Control
The hardest part of trading volatile markets is keeping your risk under control. It is crucial to use stop losses, but they need to be adjusted to the current level of volatility. Typically, you might be using a 30-pip stop loss, but in volatile markets, you got to put a 100-pip stop loss.
You need to understand the volatility and how it’s going to impact the stop loss you use.
If you’re a conservative trader, you can also limit your downside by moving your stop loss to breakeven as soon as your trade starts moving in your favor.
Alter your Usual Position Size
As with your stop loss, you also have to alter your position size. If you make your stop loss a lot wider, it doesn’t make sense to keep your position size the same. If you’re using a wider stop loss, then you should be lowering the amount of position. Otherwise, you risk losing more than your normal trades.
Follow the Short-Term Charts
On a day of massive volatility, the market can move very quickly. and following the higher time frame charts can obstruct you having a clear reading of the market price. On higher time frames you can’t detect the trends within the markets because it’s moving too quickly.
Short-term charts can give you an idea of the patterns that are forming within the markets. Taking into account the size of these price movements in very short time frames allows traders to make profitable trades in both directions of the market.
Be Reactive, Not Predictive
It’s important not to have a predetermined market bias or preconception about which direction the market should go. In a highly volatile market environment, the price can go both ways and you need to let the price tell you which direction it will go in.
Traders who strictly rely on fundamental analysts are prone to having a preconceived idea of which direction a particular market is going to go. And they will hold that bias for some period of time.
On the other hand, to successfully trade these highly volatile markets, technical analysts should be used. Technical analysis will allow a trader to treat each chart different and at its merit. Without any preconceived ideas and with only the price to follow, these highly volatile markets can be traded easier.
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