Rules for trading in volatile markets

When it comes to trading volatile markets, the first thing to remember is that volatile markets are risky markets. If you don’t have some clear rules and boundaries as you trade, or if you let your emotions run away with you then you are going to lose everything and you are going to lose it fast.

In the first section, our head trader outlines the three central rules that have allowed him to survive and thrive in volatile markets for over 20 years.

Now, fair warning, for anyone aspiring to be the next Dr Michael Burry or Mark Baum from The Big Short - this is not the report for you. Trading volatility is not about sticking to your guns and risking everything just because you know you are right. This is about tilting the risk-reward ratio in your favor so that you can come out on top.

Rule # 1: Forget Your Long Term View

Most traders, and I am no exception, like to trade with a bias. That doesn’t mean that I start every day with the same position. It just means that I am aware of the big picture influences of whatever I trade and, based on those fundamental factors, have an overarching, long term view. Right now, for example, I believe that this run up in oil will be short lived and that we need to test the lows again before a real recovery can take place.

Rule # 2: Use stop losses

Using a stop loss – a present level at which an open trade is automatically closed – is standard good practice as this can limit your downside risk and also shows trading discipline which is paramount in developing a healthy trading account. However, when markets are incredibly volatile you could experience some slippage with the position not being able to be executed at the exact level specified. In volatile markets there is often a “gap”, where a product moves substantially lower or higher than expected perhaps as much as 10-15%. With a normal stop loss you will get the first available price which could cause a large loss and result in a loss greater than your initial deposit.

Rule #3: Reduce your trade size

Margin is one of the biggest advantages of CFD trading however with any margin trading you should always be aware of how much is required to keep your position in the market. A general rule of thumb is that no single trading position should amount to risk exposure of more than 5% of your available capital. However in volatile market conditions this kind of leverage is dangerous as any loses will be magnified by even more than normal, the best market practice would be to halve your normal trading size over volatile trading conditions.

Rule #4: Limit your trades

Volatile markets are associated with high volumes of trading, which may cause delays in execution. While online trading normally means you place a trade at a current bid and offer you see, some market maker may widen bid offer spreads or even temporarily withdraw tradable prices. This means that execution can be delayed and prices to execute at may not be available. One Financial provides fixed spreads no matter what market conditions but in times of increased volatility it is sometime better to limit trade execution.

Rule #5: Stick to your strategy

During volatile times, it easy to be shaken and diverted from your normal trading strategy but most experienced traders apply the same strategy to choosing investments as they normally do. While it’s tempting to react to the volatility, it’s incredibly difficult to predict moves in the short term, so you have to stick to your trading strategies and limit your risk exposure when times are volatile.