A diverse range of markets will be closed on Friday and Monday for the Easter holidays. To add to the challenge for traders, this is an extended period with a high likelihood of major market-moving events in the Middle East. This creates a high-risk, low-liquidity situation in which typical trading dynamics are less likely to yield the desired results.
Generally, it’s a good idea to avoid unnecessary risk when trading and always stay within your risk envelope. After all, most successful traders achieve consistent results by reducing risk rather than increasing exposure. And that advice also applies in periods of unusual market behaviour, such as what we can expect over the extended weekend. However, there are some characteristics of this kind of environment that are worth mentioning, along with a few pointers.
How the Market Behaves in Low Liquidity
During holiday periods, most large market-making traders are away from their desks, which means there is less liquidity in the market. Add to this several major exchanges being closed, and then liquidity is at a minimum. This means that smaller trades can influence the market, and regular-sized trades can generate much bigger moves.
Smaller trades are often driven by events outside the markets and therefore can run counter to the logic of trading. For example, an importer needs to buy a certain amount of foreign currency to pay for a shipment. They will enter the market irrespective of the technical or even fundamental indicators. In normal conditions, this trade could be absorbed by market-makers. But in low liquidity, the trade might actually push the market at a seemingly totally random time.
Extreme Markets Require Extreme Traders
This higher market “noise” makes it harder to find ideal trade setups, so traders need to exercise extreme patience in a low-liquidity environment. Market moves might run longer, as it takes more time to exhaust buyers and sellers. This leads to a few techniques that traders might consider in these circumstances.
- Use wider stop position sizes. This, by itself, increases risk, since there is a higher chance of loss if the stop is triggered. But it helps account for the wider, less predictable swings in the market.
- Reduce position size. A corollary of the above, it reduces the amount of capital risked in the market, which limits the downside if something unexpected happens. The increased risk of a wider stop-loss can be offset by a smaller position size.
- Focus on a higher timeframe. As part of the patience mantra, using higher timeframes (hourly instead of 5 min, for example) helps cut out the noise from unexpected market moves. But it also reduces the frequency of signals, requiring more patience from the trader.
Trade Safe Is Trade in the Money
Trading psychology is also important, particularly in high-risk environments. The sudden market action might prompt a trader to jump in. But this raises the risk of overtrading. The more volatile the market, the more patience is generally recommended for the trader. Typical market setups might not work, as the market reacts to external factors rather than the usual technicals.