Increased volatility requires greater focus on risk management

I had a chat with a reporter from Smart Money the other day. She wanted to know what kind of impact the big move in EUR/USD on Wednesday following the announcement of improved dollar swap line terms would have had on forex market participants. It was a pretty easy question to answer. After all, a 200+ pip move in either direction is always going to catch half the market in a bad spot. The speed of the appreciation in EUR/USD (and other markets) in and of itself is evidence that a lot of standing orders (stops) were tripped to accelerate things along.

Of course that brings up the subject of risk management.

No matter whether you're an investor or a trader, the current market situation is a challenging one. The market is hyper-responsive to news, especially news that has to do with the Euro Zone.

Witness Monday's market reaction to word that S&P was going to put the EZ countries on negative credit watch. Was that really a significant market development? No. Just as the swap line news from last week wasn't something that altered the fundamental economic and political landscape in Europe. Nor was it something that represented a meaningful change in dollar or euro supply/demand considerations. All it did was ensure that a worst case scenario of a major bank failure due to lack of dollar funding wouldn't happen. That's why there was no follow-through.

 

 

Too often, the headlines we're seeing these days serve as reasons for short-term traders to pile in and out of positions, creating lots of volatility. This needs to be accounted for by participants at every level of involvement.

While it's true that the forex market isn't any more risky than any other market, and is less so than most, it can still hurt you badly if you aren't careful about your exposure. The EUR/USD move on the swap line news was close to 2%. A trader using 50:1 leverage would have been completely wiped out by that if he didn't have protection against that kind of move. Even a position half that size would have seen an account lose 50% of its value in less than an hour.

Whether it's through hedging in some fashion or trading smaller positions (potentially with wider stops), forex market participants these days need to guard against the market's volatility. With volumes likely to drop as we head deeper into the holiday season, the potential for rapid directional moves will only tend to increase in the weeks to come.

 

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