We recently saw a few fast and sharp corrections across a variety of markets, specifically the indexes. Now in hindsight it’s easy to say, ‘Oh this is where you should buy’, but the reality is scarcely that obvious in realtime. So how is it that you catch a sharp market pullback to try and get set for the next leg up?
First, let’s get a few things straight.
- Regardless of today’s price action, the forex market can and will change direction at any time.
- If you ‘think’ you’re risking too much in a single trade, then you probably are.
- The longer the market goes without a decent pullback, the odds are that when a pullback occurs it’ll be deeper than expected to shake off excess momentum.
- Trading with a modest exposure is a higher priority than position signals.
- Worrying about the direction of the markets day-in day-out isn’t a very good way to manage money.
- There are no guarantees and any outcome is possible when forex trading
- Set your stops and pay them the utmost respect.
Now, all that being said, here are a few ideas on how to be prepared for market moves.
Don’t predict. Follow your trading plan and react to price.
Before committing your hard-earned money to a trade, you should have a comprehensive, written set of rules that you follow, a trading plan. It should outline not only your entry and exit signals, but how much of your account to risk and how much to risk for each position. Given that everyone has a different level of tolerance toward volatility and drawdown, everyone’s trading plan can vary somewhat.
Now, just because a ‘gun economist’ says the market will crash any day now, doesn’t mean it will. It’s just an opinion, not a fact, and it won’t be a fact until it happens. That’s why you don’t put a single dollar to work based on what anyone else says. Your results are solely yours and are strictly according to your trading plan.
Drawdowns and Volatility are Natural Market Events.
Over the past couple of years, the indices have been in quite a steady uptrend, reaching new high after new high. For those who’ve been trading through a couple of bear markets, you’ll know what downside volatility looks like and can accept that market drawdowns are an inevitable, yet overall constructive market event.
Understanding timeframes and respecting risk.
Those with a longer term trading timeframe should welcome any pullbacks that arise as an opportunity to put new money to work, following whatever their price-based trading signal is. Short term traders on the other hand, may try to make profits faster, but this involves them selling at the perfect time and then buying back at the perfect time. Not to say that this can’t be done, but it is significantly more difficult.
Smaller retracements can sometimes become big pullbacks and a big pullback can turn into a bear market, and because not all pullbacks will correct quickly there’s no way to guarantee where they stop. When you follow strict risk management you’re protected against the bigger declines because you know when you’re getting out of a trade.
Don’t jump in front of a moving train
When a market is trending, often the quickest way to lose money is to try and trade against that trend, regardless of your timeframe. A trend is made up of millions of other traders and economic factors, so why would you throw caution to the wind and directly oppose market momentum?
There’s no such thing as being 100% right
One of the most important things to learn as a forex trader is that losses are a part of trading, and like it or not, there’s nothing that can be done about them. Also, there’s no such thing as an all or nothing strategy. There’s no need to only strive for triple digit returns when a handful of trades a month that net a few percent can grossly outweigh the return on any term deposit or managed fund investment.
There’s nothing wrong with trading small or sitting on the sidelines
Let’s break this down as simply as possible. Would you rather have less money at work when the forex market goes in your direction, or more money at work when the market goes against you? Reduce exposure as the trade goes in your favour or sit out when you’re unsure.
Have your watchlist ready and never chase or average down
Trading is all about the long game and slow and steady will win the race. It can be tempting after watching an instrument trend for weeks without you having a position and you might be tempted to by the first pullback as soon as it occurs. More often than not, it won’t just rebound and it can retrace further or consolidate for some time. This is why it’s important to wait for your technical signal to trigger the trade. Even a test of an MA can be a valid entry point, so don’t just run in because whipsaw and drawdown are a traders worst enemy. We’ve all been too early at least once or twice in a trade and then been whipped out by consolidation and volatility only to see the trade continue in the direction we anticipated without us on board.
Importantly, if a trade goes against you, stick to your stops and DON’T AVERAGE DOWN! No one ever went broke from reducing exposure, but plenty of people who fight the momentum of a forex pair or index and average down into a losing trade thinking that they can prove the market wrong, have. You may get lucky once, but in the long term, averaging down NEVER works.
Let’s wrap things up.
So, pullbacks happen, drawdown happens and markets go up as well as down. It’s important to have your plan in place and make any necessary adjustments, if any to keep your risk managed before it’s too late and you make emotional decisions.
In forex trading, if you think you have too much risk, then you most likely do. And if you’re not sure, then assume you do.
Source: Vantage FX Blog