There is a saying – which has now become a cliché – that goes like: “The Trend is your Friend”. Another cliché also often used in trading is “Buy the rumour and sell the news”. Now, I don’t want this article to be all about clichés, but the aim is to give the reader some psychological perspective on trading volatile markets.
What is market volatility?
Let’s first determine what volatile markets are. These are markets that are typically ones with large price fluctuations. Some technical traders look at the Average True Range (ATR) to see if there is a likelihood of extreme volatility. Those analysing fundamentals look for major news or event announcements that are likely to cause increased volatility.
Larger than normal moves create greater opportunities for both profits and losses. Most traders that I have come across with generally have a power struggle with the markets. They want to win every trade and during times of high volatility, this struggle is magnified. As you have probably read from previous articles of mine, I try to bring together the knowledge that I have gathered from various successful traders. Here, I would like to give a few tips that I have learnt from master traders on how to trade during volatile markets.
Keep calm and carry on
If you are a follower of car racing, then consider volatile markets like watching a Formula 1 race. There is lots of noise, excitement and adrenalin flowing. Everything is amplified during periods of volatility. During such times, as a trader, one of the things that will help is remaining calm. A master trader once told me that by reducing your position size, even as much as half of what you would normally trade, allows you to manage the risk better. He also said that: “Humility and acceptance that you do not control the market helps in managing the risk rather than the ego, the pride and the fact that someone else is making more money than you”.
Place your stops and position yourself wisely
For those of you who use stops or trailing stops, I think you are smarter than those who fly by the seed of their pants and go in without any stops or risk management. A general advice from successful traders is to keep them wider than you normally do. Hence, when it comes down to number crunching, one way to do this is to double the distance of your stop, although this would double the risk. However, if you also trim your position size into a half, you would be back to your normal risk profile.
Capitalise on large price swings
Now, it’s not all about managing the risk of loss. There is also another side of the spectrum, where profitability can be increased. When there are large price moves and you take proper measures of risk, you can go out there and take advantage of them, without being too greedy. Volatile markets tend to move faster and further than normal markets, so if your trade is working, don’t close it prematurely. One of the ways that some traders do it is close a portion of the trade, lock in profits, and then let the other part of the trade run as far as it can.
Create a solid trading strategy
Another characteristic of a volatile market is that it changes direction very quickly. For this very reason, the acceptance of “fear” and “greed” is vital. The moment you start chasing the market is the moment you fall into the trap, and that’s when everything goes downhill. The trick is to accept it and react fast. However, this is easier said than done, so the real trick is to have a trading plan or trading strategy for volatile markets and stick to it. Plan your trade and trade your plan. Another cliché but very apt for this market condition.
Manage your risk during times of uncertainty
Over the coming months, there are going to be periods of volatility and some periods of extreme volatility. I hope that this article has given you some insight into how to manage your emotions, trades and strategies to trade efficiently under these market conditions.