“Event risk” is a factor in all trading. Forex and commodities markets are most vulnerable, but equities are far from immune.
Factors such as Central Bank decisions and employment data can affect short and long-term trends, but at least we can have these marked on our calendars so we know when to expect them. Many traders will simply avoid trading at these times in an attempt to go about reducing risk in trading, instead looking for the gaps that appear in the economic calendar which offer a lower risk window for trading.
For example, many traders will close out all open positions the morning before the release of non-farm payroll figures, and certain trading strategies recommend that you avoid these days altogether.
Of course, revolutions across North Africa and the Middle East, cannot be mapped out on our Microsoft Outlook calendars. If we want protection against these risks, we need to get a bit smarter…
How to go about reducing risk in trading
If volatility levels are making you feel jittery, the first course of action is to build in a suitable safety margin.
A lot of traders’ automatic reaction to risk is to close in their stop levels. Unfortunately, this is unlikely to have the desired effect – in fact, it’s more likely to have the opposite effect from the one you’re after. By following this route, you may find that you’re quickly stopped out, only to find that the trade would have gone on to profit if you’d stuck with your original stop loss levels.
A better approach would be to actually widen your stop level. This gives your trade greater room to move within the increased volatility. However, this also means that you may be increasing your risk and market exposure, so I tend to combine this measure with a reduction of my stake – this way I can keep my risk levels under control.
Making the most of volatility
Where the fun really comes with volatile markets is the opportunity to ride those market movements. This could involve jumping on short-term trends or market moves and getting out of the trade before the market settles. This approach is risky, but can be very profitable if executed correctly.
In particular, scalping strategies can benefit from market volatility. In these systems, trades are only open for a short time and aim to earn just a handful of pips – stops are kept tight, and money is exposed in the market for a minimum of time.
