Student's Question:
Given the recent volatility in the financial markets, do you have any special thoughts on trading during volatile conditions?
Instructor's Answer:
Great question…
Volatility in the currency markets can come in the form of a “planned event” such as an interest rate announcement or the NFP . In those examples we know exactly when to expect the potential volatility based on the dates and times that we see on the Economic Calendar. Volatility can also come to us at totally unexpected times such as the earthquake in New Zealand and, more recently, the earthquake, tsunami and resulting nuclear disaster in Japan.
While some traders abhor volatility and will sit on the sidelines, other traders will embrace the volatility. But, within that embrace, you will find them taking measures that insure extra caution.
Let's face it, during times of market volatility, there exists the potential for gains and that certainly can be very tempting to a trader. However, anytime there is the potential for gain, there is the equal opportunity for loss. Trading definitely is a double edged sword and, as traders, we must always keep that in mind.
For those traders who do embrace the volatility, one of the most popular strategies is simply to reduce the amount that they normally trade. Our Money Management rule of thumb is to never have more than 5% of your trading account at risk at any one time. So, for a trader who has a $10,000 trading account that would mean that in “normal” market conditions, they could place $500 (5%) of their $10,000 at risk.
For example, if they are contemplating a trade that would require a 100 pip stop, under normal market conditions they could place a 5 lot trade and still be within the Money Management guidelines . In abnormal market conditions, where greater than normal volatility exists, they may cut their exposure on the trade down to 3 lots or perhaps even down to 1 lot.
In that manner they are still able to trade if they choose but without having the same amount of risk that they would take on in a normal trading scenario. It is prudent to exercise caution during times that are more volatile.