While this alone is not conclusive evidence of the inevitability of another recession, at the very least it should serve as a warning to traders underscoring the need for enhanced risk mitigation. Here are some ideas for helping to manage increased risk:
1) Reduce leverage to minimize losses
As the risk of volatility increases, one of the first things to consider is the use of leverage. Lowering leverage when volatility spikes can reduce losses, but it also lowers potential gains. Given that the main goal at this time should be capital preservation, most traders should see this as an acceptable trade-off.
2) Allow for wider price swings to avoid margin calls
On a related note, greater volatility also increases the possibility of a margin call. A margin call should be avoided as it results in the closing of open positions thereby locking-in losses. To prevent a margin call during times of greater exchange rate volatility, reduce position size or increase the amount of capital in the trading account.
3) Pay close attention to news impacting exchange rates
The events that took place around the Oct. 26 Eurozone summit illustrate the impact news can have on exchange rates. Immediately prior to the summit, when it appeared a deal to backstop Greece and prevent the spread of debt contagion to other Eurozone members was imminent, the euro received a boost.
However, on the day of the meeting, insiders suggested that an accord likely would not be reached by the end of the day and this sent the euro lower only to rebound later when it was finally announced that an agreement had in fact been achieved. This was all for naught, alas, following Papandreou’s questionable tactic to force a referendum resulting in a dramatic pull-back in the euro as investors turned to the safe haven of the U.S. dollar.
4) Closely monitor all open positions
Keep in mind that an open position is exposed to market price fluctuations. If it is not possible to actively monitor an open position — especially during periods of enhanced volatility — be sure to use automated tools such as stop-loss and take-profit instructions to automatically exit positions.
5) When in doubt, don’t trade
Sometimes the best option is simply not to trade. If it is not possible to sufficiently analyze current events and actively supervise open positions, consider remaining on the sidelines until conditions are more favorable.
It sometimes is easy to forget when you are a trader that you have this option, but many of the most successful traders will tell you that some of their best trades are the ones they didn’t make.
Scott Boyd is a content writer specializing in the financial sector, Boyd has produced educational materials and conducted market analysis for several of Canada’s leading financial institutions. He contributes articles on the global currency markets to the OANDA blog.