theforexwriter’s Weblog

Surviving in a volatile market July 1, 2008

In the last two weeks, my mini account got hit hard. I executed several poorly-timed trades, twice entering the market just as it turned south and moved against me without warning, for losses of just over 10% of my account.

In one of those trades, I went long the AUD/JPY just as a fresh round of risk aversion slammed the market, but I assumed it was just some big traders taking profit off the table, moved my stop down to a level that I figured would never get hit, and went to bed. In the morning, my equity and my jaw both dropped.

Don’t get me wrong. I can deal with the market moving against me; it happens to everyone whether they admit it or not. The trick, though, is to minimize the losses and maximize the gains through good money management, not to ASS*U*ME that a certain level of support will make a good stop-loss level and then turn out the light. I mean, I should have just donated the money to my favorite charity and saved myself a lousy morning.

So here, for all to see and gloat over, are some rules of survival in a volatile and choppy market.

Keep the fundamental announcement calendar right by the keyboard. Economics are kinda chancy these days, with many reserve banks stuck between rising inflation and falling growth. They can’t raise interest rates without risking weaker growth and they can’t lower rates without risking stronger inflation, and everybody knows it. So traders are watching fundamentals closely, hoping to confirm or refute expectations of future interest rate and therefore market movements.

When an announcement is pending, think about exiting trades associated with that currency, unless of course you’re absolutely certain what it’s going to say, and even then, consider getting out. Economic indicators have been surprising both experts and amateurs lately, and the market has been moving radically in response. As an example, when the FOMC released their interest rate decision last week, the market at first interpreted the accompanying statement as hawkish and the dollar started rising, only to fall off a cliff a few minutes later. A lot of amateur traders got slammed.

When the ECB moves this Thursday, it’s likely to happen again, so hang onto your hard hat and your money. Consider waiting until the direction of the market’s move has been confirmed before joining it.

Don’t trust the market. A choppy and volatile market is no place to ignore basic good trading skills. Take the time to mark support and resistance levels; look for channels, Fibonacci retracements, and chart patterns; calculate ADR levels; and look for levels where more than one of these technical indicators coincide. That’s where the bulls and bears are likely to make their stands, where the market is likely to turn, and likely spots for an entry or exit. Look for confirmation (as I should have done) before committing to the trade, and use good money management techniques, never risking more than your established maximum amount per trade.

Check the chop before you dive in. A trick I learned from Dean Malone of CompassFX is the five-period moving average channel, with one SMA calculated on the high price and the other on the low (an example is visible on the USD/CAD chart below). Check the price action on the four-hour chart before trading. If it shows a series of dojis, spinning tops, and random bull and bear candles clustering within the channel, then the market is choppy and it will be even harder to grab a few pips than normal.

Trade pullbacks, as the 5EMAs trading system teaches. Movements aren’t likely to be sustained for long, as many currency pairs, particularly USD crosses, are pulling inside rather narrow ranges like tortoises inside their shells. When an honest profit has been made, consider taking it off the table. The alternative is to see a good trade head south, taking your profit with it.

Trade channels and place hedges above and below for breakouts. As the daily chart of USD/CAD below graphically illustrates, range-trading is in right now. Since late November of last year, USD/CAD has moved within three cents, plus or minus, of parity (marked by the central red horizontal line) and although a number of pundits are predicting it will rise out of that range later this year, well, it hasn’t yet.

There’s a lot of inherent risk in the forex trading market, and I generally expect one-third to one-half of my trades to go against me. More than ever, in a volatile market the rules should apply:

1. Have a strategy.

2. Plan your trade.

3. Trade your plan.

4. There’s no such thing as always.

Happy trades to you.