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Adjusting for Risk in Volatile Conditions

   

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Volatility is an unavoidable part of forex trading. But that doesn’t mean it’s necessarily a bad thing: Many traders seek out volatility to generate profits from trades. And almost every trader understands the relationship between risk and reward: If you want to earn a profit from forex trading, you need to be comfortable with a certain degree of risk.

Nevertheless, too much volatility can rattle traders and call existing strategies into question. The recent market upheaval created by the COVID-19 pandemic is the perfect example of volatile conditions that have little precedent and can strike fear into traders. Some adjustments to your risk profile may be necessary, but there are also opportunities to take advantage of this volatility and use your analysis to forecast the long-term implications of ongoing market volatility.

The Difference Between Market Volatility and Uncertainty

The key difference between volatility and uncertainty has to do with the time frames in which these trends are occurring. Volatility happens in the moment as a response to any number of influences. With the COVID-19 crisis, volatility was created on several fronts, such as when Chinese production of goods slowed down, and then later, when buyers of those supplies went into shutdown and demand slowed down. 

Uncertainty is a related market factor, with an important distinction: Rather than being grounded in the moment, uncertainty is based on future projections of how long the volatility and its causes will last. Again, to use the COVID-19 example: When will U.S. businesses be able to return to normal operations, and what permanent changes or damage will they have suffered? Uncertainty can affect demand for certain currencies, resulting in price movement fueled by traders who are trying to calculate this uncertainty.

Even the trade relations between certain countries can affect uncertainty. Rising political tensions between the U.S. and China have already added uncertainty to the global economy, and this uncertainty is expected to carry on for years.

Steps You Can Take to Adjust for Risk

Volatility in the markets isn’t a reason to stop trading. Opportunities are still out there. Instead, focus on changing your behavior and adjusting your strategy to account for these new market dynamics. Here are some steps you can take:

  • Don’t jump on price movements until you have direction. As you try to assess your trading opportunities, don’t get too aggressive or jump in because you’re worried about missing out on a profit. Take your time and survey trade opportunities until you find one that looks right. One tip: Look for a good place to set a stop-loss order. If you get some sense of direction, a stop-loss based on a pullback can help set the floor.
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  • Explore different trading instruments. If you’re used to trading on oil, for example, maybe switch your approach and trade on CAD, which is closely correlated but offers a little more stability.
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  • Widen your stop-loss. During times of volatility, a little extra wiggle room is necessary. You always want to minimize your losses, of course, but during periods of volatility in which price direction can be tough to analyze, a wider stop-loss can help you account for prices that are unlikely to move in a straight line.
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  • Reduce your position size. If you have too large of a position size during periods of uncertainty or volatility, a single bad trade on a large position can blow up your account. Reducing your position size helps you manage your risk while still creating profit potential.
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  • Move to a wider time frame. Changing your time frame can help eliminate the “noise” that comes with external influences, such as economic news.
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  • Don’t make trades based on rumors and opinions. Unsubstantiated claims and bad “advice” only exacerbate volatility and uncertainty while making it more difficult to make educated trades. Stick to the hard facts that you know you can rely on.

Advice on Using Indicators When Making Forex Trades 

Lines of support and resistance remain reliable tools for evaluating price movements, even during volatile and uncertain conditions, but keep in mind that technical indicators lose some of their value in a volatile market. They aren’t reliable tools for evaluating trade opportunities because volatility is often driven by external factors that these indicators can’t account for.

In an uncertain market, however, these indicators can be a great resource for analysis. They are more reflective of trader sentiment, which is closely aligned with market uncertainty. As volatility in forex markets gives way to uncertainty, incorporate these indicators back into your trading strategy.

Market volatility should always be taken seriously and approached with caution. Avoid impulsive decisions when you’re looking for trading opportunities. With so much instability affecting the market, sometimes the best trade you can make is no trade at all.

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Disclaimer:

The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.

This post was written by Graeme Watkins

CEO Valutrades Limited, Graeme Watkins is an FX and CFD market veteran with more than 10 years experience. Key roles include management, senior systems and controls, sales, project management and operations. Graeme has help significant roles for both brokerages and technology platforms.

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