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Forex: managing volatility
Gavin White, Head of Sales, City Index
Compared to trading CFDs on shares, I find that the FX market is more volatile and I keep getting stopped out quickly. Should I be placing wider stops on FX than share CFDs, even though it increases my risk?
Volatility is a good thing. Volatility brings opportunity for a trader and it can be your best friend as long as you are flexible with your position size and rigid with your money management.
Where you place your stop loss and how much you risk on a trade are two separate questions that I believe should be determined independently of each other. I also believe they should be the first variables you decide in the trading process (apart from whether to go long or short). Put together, they tell you what your position size should be.
How much you risk on a trade should be determined solely by your pre-determined money management plan and your level of confidence in the trade.
Where you place your stop should be determined with reference to the recent volatility of the underlying market (that is, it is not prudent to leave a close stop loss in a market that is extremely volatile) and also with reference to the technical environment in that market (that is, stops should be placed relative to support and resistance levels evident on the chart of the underlying market).
I don’t believe you should be changing your risk amount for different asset classes as a rule. If you need to place wider stops because a contract is volatile, or because technical levels are further away, this should not affect the amount you have already determined you would risk. You should, in these circumstances, simply reduce your position size so that you can leave your stop loss at the desired level while still risking the same amount.
If you can’t afford to leave your stop loss at the level you think it should be, you should cut some of your position until you can afford to leave the stop loss at the desired level.
As my first Chief Dealer advised me more than 20 years ago; “Never be afraid to reduce your position size. Money management overrules everything else”.
Having said all this, I’m not so sure FX markets are more volatile than equity markets.
Gavin White, Head of Sales, City Index
Disclaimers: The views expressed in this article are those of Gavin White, a representative of City Index and is not intended as general advice. This does not constitute a recommendation nor does it take into account your investment objectives, financial situation nor particular needs.
Our panel of experts are available to answer any questions you have on products and strategies, or simply to explain a particular term. The team consists of experts on CFDs, Forex, Broking, Options, Warrants, Futures and ETFs.If you've got a question, you can post it at: Your 2 Cents, in the 'Ask the Expert' section.
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