Major Events: Trading Risk Management Strategies [Part 1]
One of the challenges of forex trading is dealing with major events that cause market volatility. Major events can be anything from political elections, central bank decisions, natural disasters, or global pandemics. These events can create large price movements in a short period of time, which can be both risky and rewarding for traders. Therefore, instead of avoiding trading during major events, traders should apply effective trading risk management strategies to protect their capital and take advantage of the opportunities.
It also goes without saying that what’s best to do will depend mostly on your strategy. There are some high-risk traders who positively thrive on the high-stakes, high-stress environment of trading the news. Generally this isn’t recommended for most traders, precisely because the vast, vast majority of traders ultimately are consistently successful because they avoid risk.
The (dis)advantage of volatility
A lot of ups and downs in the market would presumably generate more trade signals. It also comes with higher risk. The problem with unusual volatility, which comes from a major event, is that it can mess up the signals you are using to trade. This is particularly relevant if you are a technical trader, relying on indicators for signals. When the market is uncharacteristically volatile, then the data used by the indicator to generate signals can be distorted. It can miss signals, or generate false signals.
Let’s consider a simple example: Say a pair generally moves around 10-20 pip increments per time period. An event comes along that pushes the pair up by 100 pips. The indicators that are averaging out market moves will have this 5x to 10x jump in that one time period. If your indicator is tracking, say, the prior 10 candles, a 10x jump will completely overwhelm any of the moves in the indicator period. There could be a signal to enter the market, but won’t show because the indicator has been distorted by this one data point that is very much out of line with the normal course of trading.
When to avoid a major event
Major events move the market when they catch it by surprise. That is, everyone expects a certain result, and sets up their trades accordingly. Then the result is different, forcing traders to reposition, causing the market to move. If you are banking on catching that move, you are by definition betting against the market – a seriously risky proposition. Since what moved the market is a surprise, the move can be in either direction and is very difficult to predict.
This is why trading risk management is crucial before and after major events. You should review your stop losses ahead of the event to ensure they will protect you in case the market moves in the wrong direction. But then after the event, you should also be aware that your indicators are distorted by the large move. Knowing the period that the indicators are timed for will help you know when the market move distortion has worked its way out of your trading system, and you can resume trading normally. For example, if your indicator tracks the last 14 candles, then you might want to avoid trading until 14 candles have passed since the last major event to make sure it still isn’t influencing your indicators.