How to keep calm and trade in volatile markets
We are navigating a period unprecedented volatility. Compounding this effect is the fact that it was preceded by one of the longest running bull markets in recent history. And the end of this volatility doesn't seem to be close.
In just two months from February to April, the iPath S&P 500 VIX Short Term Futures exchange-traded note (VXX) - when traded into US dollars - has seen a steep and almost unbelievable climb of 60%. Although the risk is evident, volatility can also present unique opportunity, if it's managed correctly.
So, what do you do as a trader and investor?
Do you let fear overcome you and move to low risk/low yield investments? Or do you buy the dip? Is keeping your money in financial limbo the safest, especially considering financial institutions and central banks are constantly lowering interest rates?
Risk management, rinse and repeat
As volatility increases so does the need for more robust risk management. You need to ensure your strategy includes multiple protections:
- Guaranteed stop loss
Protecting your trades with a stop loss order allows you to avoid two hazards present during a volatile market; surpassing your risk target/appetite and margin stop out. The second only true when trading leveraged products and derivatives. If your stop loss order isn't guaranteed it could result in both unforeseen losses and even potential negative balances.
- Cancel out of losing trades
While hedging your trades against losses may sound too complex for the average retail trader, it is a common practice with the professionals. There are innovative new tools out there to make this easy, regardless of your degree of savviness. For example, easyMarkets offers a unique tool that allows you to undo losing trades within a window of one, three and six hours, for a small fee.
- Guaranteed take profit
This type of order protects your profits against an unexpected trend reversal, just like the reversal VXX/USD experienced on April 15 (see chart).
- Fixed spreads
Inversely, brokers' spreads (floating or variable) are subject to fluctuations during trading, increasing or decreasing them depending on market liquidity and volatility. This can cause an unforeseen increase in costs when trading, resulting in an otherwise profitable trading session to end up in the red. It also gives you price transparency allowing you to better calculate and refine your P/L and risk to reward ratio.
- No slippage
This is excruciatingly important when markets are experiencing high volatility and prices are fluctuating rapidly. No slippage means that your trade will be executed at the rate you intended it to, not at a higher or lower rate that can unexpected losses.
- Negative balance protection
While many brokers sneakily add in the small print 'losses can exceed deposits', other brokers build in measures to protect their clients against this. When trading in volatile markets, you can avoid a worst-case scenario of ending up in negative equity from a 'market gap event' for example, by ensuring your broker has negative balance protection as a standard feature.
- Interest on deposits
Using data published by the Reserve Bank of Australia, Trading Economics reports that as of March 2020, Australia's average interest on deposits has reached a historic low of 0.9%. In March, the RBA also lowered its cash rate by 0.25 percentage points bringing it to a historic low of 0.25%.
The cash rate or base interest rate is directly correlated not only to lending interest rates that financial institutions offer but also interest rates paid on savings. This negative trend seems to have been developing throughout the past decade, albeit with a sharp decline since the beginning of the year. If this trend continues eventually interest rates will move into negative figures - as will interest paid on deposits.
Australian bank interest rates compared
Further proof of the drop of interest rates on deposits, we have compiled a list of what interest rates some of Australia's biggest banks (also known as the "big four") are currently offering. This is the interest rate paid on deposits for a period of 12 months.
Trade and earn 2% interest
easyMarkets, a local, licensed and regulated financial service provider offering contracts for difference (CFD) and options brokerage, recently launched an incentive program which pays 2% interest on deposits - a return which is higher than the big four banks' 12-month term deposit rate. To be eligible your deposit must be between $50,000 and $500,000 and you must have traded 25 standard lots per month (subject to terms and conditions).
With an easyMarkets account, an active trader can benefit not only from their trading activity but also from interest earned on their deposits, rather than watching it stagnate in a bank account. This well-established, Australian regulated broker offers trading on its proprietary platform, iOS and Android app and MT4 for more advanced traders.
This is a limited time offer to help new and current clients navigate this exceptionally volatile period. To learn more, please visit easyMarkets.com.