11.03.2016

Trading in the Age of Volatility (by Alfonso Esparza, OANDA)

There is very little time in the fast-moving Forex market to dwell on the past. The best traders learn and move on. However, the last year and a half has seen a number of events that forced market participants to fundamentally reconsider the way they operate.

The most prominent example was the Swiss Franc crisis. The end of the EUR/CHF peg on 15th January 2015 wasn’t the first major shock the markets had ever faced, but it was set apart by the lack of consistency in the Swiss National Bank’s (SNB) position.

Since then, we’ve seen one of the most unpredictable and volatile currency markets in recent memory. Earlier this year turbulence amongst the main G7 currencies surged to the highest annual average since 2011 according to a JPMorgan Chase & Co’s index. However, it hasn’t just been central bank announcements, jobs data, inflation or other macro-economic indicators that have spurred volatility. Far from it. It has also been driven by political uncertainty.

The year’s defining moment for currency markets may have come in June with the UK referendum on the EU. Major currency volatility soared as the result shook markets, sending the pound to the lowest in more than three decades. Brexit-related aftershocks then ensued, the latest of which wiped 6% off the Pound overnight.

The US presidential election looms as yet another political event that will shake up markets.

Lessons learnt from Brexit and the Swiss Franc crisis will likely need to be exercised on November 8th and 9th. For retail traders, it will be a reminder of the importance of taking a proactive approach to risk management and intelligence gathering. A multi-faceted trading strategy based on a number of well-researched sources will be crucial in the continual battle to de-risk. In many ways this is trading 101; just as diversification is important for investment, a solid decision-making strategy will draw on a wide variety of information channels. Charts and analyst reports need to be in the mix, but keeping an eagle-eye on the news is also vital.

All the information in the world will only get you so far, however. As the SNB and Brexit events prove, black swan events can and do happen. Traders need to be prepared for the unexpected. Additional risk management methods are needed to provide resilience against shocks.

Staying disciplined with a set, balanced strategy which aims for consistency rather than irregular big wins is also key. As is containing downside by keeping trade sizes small and properly employing stop losses. That’s in addition to managing cash effectively by setting a budget and sticking to it rather than chasing a succession of upsides by leaving cash on the table for too long.

Good risk management is a complex affair, full of nuance. For this reason, a proper risk management education, whereby traders come to understand the dangers of techniques such as over-leveraging while having access to a full suite of tools and algorithms to help guide their strategies, is essential.

That being said, being prepared and having the right risk management strategy in place will only be effective if traders can rely on a trading partner that can execute a trade as quickly as possible. For retail traders, the speed at which the trading engine executes their order can often be the difference between getting the price quoted or not, between being on the right side of volatility rather than the wrong one. In many ways, the speed of execution of trades – especially in times of intense market volatility – is just as important as a trader’s ability to manage risk during market movements.

The volatility is unlikely to stop for the remainder of 2016 and into 2017. The fallout from the US election, a potential Fed rate rise in December, the UK’s Brexit negotiations, China, uncertainty in the Middle East, and concerns over emerging markets, will all be big contributing factors. But as the differences between the winners and the losers of the Brexit fallout and the SNB crisis demonstrate, a serious and smart approach to risk management and speed of execution makes all the difference.

 

 

Past performance is not indicative of future results. This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities.

 

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