What to do with your trades when chaos reigns
Holy smokes – did you see the market carnage on Monday?
Traders had been anticipating further currency devaluation from China after the weekend, and when it didn’t come all hell was unleashed!
The Shanghai index had already dropped nearly 8.5% overnight, and this sell-off lit the blue touch paper in markets across the globe as they came online on Monday…
European share indices plummeted and US equities plunged.
The Dow Jones Index was down over 1,182 points at one point. It showed a 7% decline since the close on Friday. Of course, that all happened before a ‘mystery shopper’ stepped in with huge buy orders and lifted the index back 900 points off the daily lows.
Was this the US Government’s fabled ‘Plunge Protection Team’ working hard to restore price levels to where they think they should be? I guess we’ll never know for sure, but I’ll tell you what, it certainly makes for interesting conditions!
Now when we look at events like this I’m going to ask you to think about the markets from 2 perspectives: the investor and the trader.
The investor will be looking to park his money up long term. Buy into some shares or something and let nature take its course. Hopefully growing his wealth on autopilot as time goes by.
If you’re an investor caught up in whipsaw moves like Monday’s, then yes, you will have important things to think about.
And it’s the investor that the media will be targeting with their hype. You might have seen stories on the news last night and in this morning’s papers: fear sells after all. And what great stories to do the selling for them: Bloodbath in the Markets and all.
I do have sympathy for investors though. It is always going to be pretty scary watching the value of your life savings leap up and down minute by minute.
But we’re not really looking at the markets from the perspective of the investor. The ‘blood in the streets’ scare stories don’t really apply to us traders. Here’s why…
Trader Vs Investor
The trader is lighter on his feet and more opportunistic than the investor. He doesn’t care whether the markets go up or down because he can make money either way. He can buy low and sell high to make his money. Or he can sell high and buy back lower to make money. He’s only interested in whether the markets move. Movement puts bread on his table. But it’s got to be movement within reason.
Let me explain…
When the markets cease to function within the thresholds of normal activity, like they did on Monday, most players make a run for the exits. They get the hell out and watch from the sidelines until the dust settles.
This has a big effect on the market. The buying and selling pressures that normally push and pull against each other – keeping the market vaguely in check – disappear.
It means markets that normally bob up and down at a relatively sedate pace turn into raging monsters. This is because there is no buying or selling interest in the market to complete both sides of a transaction at a tightly matched price.
A seller might want to shift his inventory instantly, at the most recent price, but in fast-moving markets the nearest buyer might only be willing to step in several points lower. The buyer might not see any value in buying until the market drops down to his price, so that’s where the transaction takes place – at the nearest buyers bid price.
It’s something that can easily frustrate traders: I hit sell when the market was at 80 so why did I get this lousy fill 7 points lower at 73?
But even spread bet firms are affected by the withdrawal of liquidity (that’s what it’s called when market players bold for the door).
They can only offer prices and conditions which reflect the underlying market.
When slippage becomes your sworn enemy
So when you get ‘slippage’ of, say, 7 points on your fill price (slippage is the difference between the price you were expecting and the fill price you received), it’s only a reflection of real-world conditions. It shouldn’t come as too much of a surprise, especially when you’re already watching the market leap around like a wild thing.
But to see what’s really going on, let’s look at this through the lens of an example trade…
Let’s say a trader was active in USDJPY on Monday. He had a short-term bullish outlook so he was long the market. He was looking to make money from an up-move.
Now when the markets started to tank he might have wanted to get rid of that position as soon as possible. That sounds pretty reasonable doesn’t it?
But I’m going to show you how massive slippage can occur in conditions like this, and how that can have a devastating effect on his trading account.
We’ll make a start looking at a regular candlestick chart, but it’s a very short-term one. Each of the candlesticks shows just 3 seconds of trading activity. Remember that, it’s important!
Here we go…
So let’s say that despite being aware of very thin (low liquidity) conditions, this trader insisted on continuing to trade.
He finally pulled the plug on his long trade at point A. He’d had enough and wanted out. But by the time he’d pressed the button, and his order had been routed through to his broker, the market was already trading at point B – that’s just 3 seconds later.
It’s a difference of 5 pips. So it’s not difficult to see how slippage can occur in low liquidity conditions.
Now 5 pips are bad enough, but take a look at what happens just minutes later…
The distance between point C and point D is 52 pips!
And do you know how long it took the market to travel that far? Just 6 seconds.
You can see the huge gaps between the candlesticks where no buying interest came in at all. The market was swamped with sell orders and the buyers were nowhere to be seen. That’s what drove price down so aggressively.
Is it possible to still trade profitably in these markets?
Yes, it is still possible to make profitable short-term trades in volatile markets, but there is a caveat: There are times – like on Monday – when you should simply sit on the sidelines until you see a level of normality return.
Keep an eye on the way the last price changes as the trades go through. If the market is jumping 5, 6, 10 pips each time it means there is no liquidity present.
So it’s one thing to pore over charts at the end of the day and fantasise about riding rapid plunges to the downside, but let me assure you, it’s no place to be risking your trading bank. The huge difference between anticipated fill prices and actual fill prices – once slippage has made its mark – is simply not worth the risk.
There will always be other opportunities. I think it’s better to watch low liquidity carnage play out without getting involved.
Jealously guard and protect your trading bank in times like this. You have the luxury of choosing when to do battle in the markets.
Just because the markets are open doesn’t mean you always have to trade!
Be Prepared: Market Moving Data Coming This Week (London Time)
Wednesday 26th August
13:30 USD Durable Goods
Thursday 27th August
13:30 USD GDP
15:00 USD Pending Home Sales
Friday 28th August
09:30 GBP GDP
Monday 31st August
All day – UK Bank Holiday
10:00 EUR CPI
Tuesday 1st September
05:30 AUD Interest Rate Decision
08:55 EUR German Manufacturing PMI
08:55 EUR German Unemployment Change
09:30 GBP Manufacturing PMI
15:00 USD ISM Manufacturing
As well as the scheduled data releases we obviously have very high levels of volatility in the markets at the moment. Please do trade responsibly and stay within your own tolerance for risk whatever the markets get up to next!
Until next time, happy trading!