Hello traders! This week’s newsletter will be focused on risk management during news events, like the recent U.S. midterm elections and, specifically, in the Forex markets. It is often said that traders are really just risk managers, albeit on smaller time frames than most people think. So how do we quantify and manage our risk during volatile trading times?
One of the great things about trading is that we have some very obvious times when we can expect increased volatility, and these events can be found on nearly any economic calendar. Some events are very important, like central bank interest rate decisions; and some have very little effect on our forex markets, like production numbers from small countries in the Eurozone. Knowing what the expected effect will be can help us with our trading and risk management, but how?
Whenever a significant event is on the economic calendar, I change my trading behavior to minimize my risk. There are several ways that you can do this, here is a short list with pros and cons:
- Get out of the market ahead of time and wait for it to settle down to re-enter. This is the easiest and safest risk management strategy. Part of the problem with economic events is that the spreads of our pairs usually widen, meaning the liquidity is drying up which may lead to our stop loss orders not getting filled exactly where we expect. This added risk uncertainty makes very conservative traders exit ahead of the news event.
Pro: Zero added risk!
Con: May potentially miss out on significant moves.
- Exit half of your position size before the news. If you have a profit of say 100 pips on 2 lots going into a big event, you could exit half of your position to lock in those pips, but still give your remaining position a chance to run.
Pro: Locks in profits reducing the risk of staying in with your whole position while also giving the trade a chance to become a big winner.
Con: Adds risk on the half you still have invested which could possibly lead to giving back all of the profit on your remaining position.
- Do nothing and let the market do what it will. Your stop may get hit, with possible slippage; but at least you are giving it a chance to have a big move.
Pro: Potential to gain a lot of pips.
Con: A crazy move may wipe out profits and result in a large loss!
If you are an inexperienced trader, I usually recommend risk management option number 1 until you have a few trades under your belt. Otherwise, you may freak out when you see your profit and loss go up 50 pips, down 50 pips, back up 50 pips, then back down 50 pips in a matter of seconds! That type of volatility causes new traders to trade with too much emotion, which always leads to unnecessary losses.
My preferred risk management strategy is to exit trades right before the news event, then trade the inevitable retracements and subsequent moves that nearly always happen.
The great thing about news trades is the fact that the markets are trading with such high emotion that it becomes very predictable. Why? Because people’s fear and greed in fast moving markets have never changed in the history of trading, which makes the patterns nearly the same thing over and over again. If it’s a repeating pattern, it’s tradable!
So in the beginning, please reduce your risk. After you’ve seen a few dozen big news events move the market, you will start to recognize the same moves before and after the event. Buy in institutional demand and sell in institutional supply, and let the pips roll in!
Until next time,