By Kris Sayce
You have probably been reading in the press recently about the high levels of volatility on the stock market. It is because of this and the ASIC ban on short selling, that many traders are looking for other markets to trade.
But where do you look? Everything is volatile. In reality you’ve got two choices. You can either sit on the sidelines in cash – maybe not such a great idea with interest rates falling. Or you can look for a market that is used to volatility, that trades 24 hours per day, and where you can trade in rising and falling markets.
That’s where trading foreign exchange fits into the picture. And it is also why CFD providers are seeing a healthy level in FX trades.
Because the FX market trades 24 hours a day it has another benefit over share trading. The increased volatility on the stock market has seen an increase in shares gapping up or down when the market opens. In the FX market price gaps are less frequent due to the non-stop trading.
Despite that, it isn’t all plain sailing with FX trading. Any trader will tell you that. The FX market can be very volatile, and if you’re not prepared for it, it can play havoc with your trading plan. There is one crucial area that it can be especially damaging, that is when trying to manage your stop loss orders.
Stop loss orders are crucial. For many traders the stop loss order is the key to the number one rule of trading – preserving your capital. After all, if you lose your capital then you’ve got nothing left to trade with. If you think about it, a trader with no capital is like a shopkeeper with no stock.
That’s why most successful traders will always use stop losses as protection on the downside. The only problem with this strategy is that as market volatility increases there is a greater chance of your stop loss being hit. That’s fine if the trade continues to move against you because you’ve saved yourself from further losses. But the greater volatility also means the position could easily turn and move back in the opposite direction. Of course, that’s no good to you as you’ve already been stopped out and have locked in a loss. Here’s an example of how a stop loss order can help you minimise your losses if a trade goes against you:
If you hadn’t used a stop loss order, the trade could have move further against you, resulting in a bigger loss…
But of course, if the position reversed direction and went in your favour you could have ended up in profit…
But that’s a high risk strategy in this market. Are you prepared to risk $317 in order to make $151? So, as an FX trader, what can you do to make sure you’re protecting your downside whilst not racking up big transaction costs from over-trading?
Who better to ask than someone who’s been at the coal face of FX trading? I spoke to Chris Fulton, a former FX trader at a major Australian bank and now a manager for CMC Markets. Chris told me, “FX markets go through periods of volatility, whether they are central bank underlying rate movements or economic indicators such as CPI or retail sales. Therefore, it’s important to be nimble and adjust your trading style to suit.”
That’s the key, you’ve got to be “nimble.” In other words, a strategy that may have worked under one set of market conditions may not work under another. So, how do you put that into practice?
Chris Fulton says “This could be as simple as later entry into positions, with closer stops [stop loss orders] and a smaller time frame for profit, looking at hourly or minute charts rather than daily or weekly. Overall though it’s important to recognise that markets can move quickly, and it’s not necessarily the best time to run positions over a long time frame or let stops run.”
And according to Ben Potter at IG Markets in Melbourne, their clients have adapted their trading to the current market conditions. He told me he has “noticed an increase in the number of clients trading very short timeframes, trying to pick up 10-20 pips per day. Stops in general are being set tighter to help protect capital during these times.”
Not only that, it also seems as though many FX traders are adapting their trading techniques further by picking up some good habits along the way. Ben explains, “We’ve seen a significant increase in the number of clients trading with stop losses.”
In some ways it would appear to be counter-intuitive to place your stop loss order nearer to the current market price when the market is making bigger movements. But the reasoning is sound. Because once the market starts to move against you, the best thing to do is to get out for as small a loss as possible and reassess the market.
The one thing you don’t want to do is to stop using stop loss orders. Once you do that, your emotions can very quickly take over your trading and before you know it you can be looking at a big loss.