How to Deal with Volatility in Forex Trading

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The currency markets are generally considered to be volatile in nature. The volatility is usually magnified by the use of leverage by the participating traders. There are certain things that traders have to do to survive volatile markets. This is a short guide to surviving a volatile currency trading environment.

Trading Psychology

Trading psychology is about controlling your emotions. The mood of the trader can have a profound effect on how he or she views the market. Here are a few major psychological hurdles that are particular during volatile markets.

Deal with your losses

Sometimes you just have to admit when you are plain wrong about a trade that you made. If an extra volatile market, even holding on to a bad trade for an extra day can cost you plenty. It is better to admit when you are clearly wrong and cut a small loss before it can become a sizable loss.

Deal with your gains

It might seem silly, but you have to also figure out a rational way to deal with your winning trades. It seems simple, but winning trades can put you off balance by making you feel like you cannot make a mistake. It’s important to keep an objective eye, even if you are making a large amount of winning trades.

Know when to back off

Sometimes the market lacks any kind of sense whatsoever. It will keep pulling you in, and then taking out your stop and dragging your account balance down. It’s ok, to step back and leave the market for awhile until it settles down. There is money to be made every day.

Risk Management

There could be no better time to use proper risk management than during a volatile market. Risk management can save your trading account!

Position Sizing

When the swings are wild, trade smaller. The size of the moves will make up for smaller position size. A large position size will just make you feel nervous as the market whips around with your trade. This could make you do something you will regret later when the market takes off on your intended direction.

Correct use of Stops

Special care needs to be taken on the placing of stops in an overly volatile market. Most of the time, tight stops will not work at all in a wild market. Trades will need room to breathe. Otherwise traders can be stopped out often by price whipsaws. If using the proper position sizing, it is ok to use a wide stop to let your trade breathe.

Lock in gains often

Once the market moves in your preferred direction and your trade is in the money, do not hesitate to adjust your stop and lock in some of those gains. There is no shame in getting stopped out for a gain, large or small. When markets are out of control, you have to use every little edge you can get. Locking in your gains as often as you can will insure that you end up with gains rather than losses.

Mistakes to Avoid

There are some forex mistakes that traders need to avoid in general. Those mistakes can hurt 10 times as much if you make them in a volatile market.

Large Position Sizes

I cannot stress this enough, take a smaller position size. Take a position size that you could handle seeing terribly negative, if you had to. It’s not to say that you want to have negative trades sitting on your account, but having smaller position sizes will keep your head level if they come under pressure. You might not make a fortune on each trade, but your account will survive to see the next trading day.

Averaging Down

Averaging down is when you are in a losing trade, and you take another position to try to make your average entry price lower. This is a strategy that can work under certain conditions, but it is very dangerous in a volatile market. Most traders will try to keep averaging down because they expect that the trade will turn at any moment. The losses will get larger and larger, more than you might have ever imagined, and you end up with a blown account. It is generally a bad idea to average down at all, it usually results in disaster.

Do not try to pick the point where you think price will turn around. This is one of the number one killers of trading account equity. Picking tops and bottoms has to do with trader ego. It is not necessary to beat the market by figuring out the turn. You can simply follow the trends and use reasonable stops and you will make money. You will find that volatile markets can surprise you on how far they will go, and how fast they will get there. Stay away from trying to pick tops and bottoms and avoid becoming a casualty of a fast market.

Summary

Take care of yourself as a trader. When markets are volatile, be conservative and follow the rules of the trading road. Volatile markets plus leverage can be painful to your account. There are old traders, and there are bold traders, but there are no old and bold traders. There is a reason for that!