By Sam Evans, Co-Founder & CEO
In recent weeks the major stock indices have lacked a clear direction, yet we have definitely seen a major increase in volatility. Looking at Dow Jones industrial average, at the end of January the average daily movement was around 300 points, yet today is almost 450 points. While most active traders and investors find it challenging enough to call the direction, added volatility becomes an extra thorn in the side of many. As market speed increases, there is a greater need to be patient and allow things to play out. We will often see the markets moving in one direction, only to reverse quickly in the opposite direction. Some love volatility, but many seasoned traders treat it with an air of caution. I personally am one of those who likes to take a cautious approach. Let me share my reasons why.
Don’t get me wrong, volatility can be exciting. When markets move hundreds of points in the blink of an eye, we can see huge and fast profits on our trades. On the other hand, we can also see major losses as well. It can be very easy for an amateur speculator to jump in and try to ride the movement as it’s happening. This leads to people chasing the price. Getting suckered in to joining a move when it’s already happened. It is important to sit back, wait for extreme prices, and then pull the trigger. Unfortunately, most amateur and retail speculators either have no training or have not been trained effectively on how to do this. For me, no matter the volatility it’s business as normal. I expect things to happen faster, but I also expect things to become choppier too.
With this in mind, it can make good sense to be more generous with the entries, stop losses and targets. None of us really know what the market conditions are going to be like from one day to the next. That does not mean that we cannot be prepared though. My first piece of advice to anyone struggling in volatile market conditions, would be to start looking at the bigger picture and avoid the small fast time frames. If you spend your life looking at short timeframe charts, you will often be misled as to what the true directional potential of the market really is. You will also run the risk of continually being taken out of a position, only to then see it move in your favor.
We will have both good and bad days, that’s just part of the business. However, it is vital to make sure that no matter the conditions, we stick to our plan at all times. Any solid trading and investing plan should be centered around strict risk management criteria. You may have heard of the importance of a risk to reward ratio? If not, it’s time to pay attention! And if you have heard of it, you should be asking yourself right now whether you truly embrace the concept of it? Let us dive a little deeper into some recent trading action of my own.
Below is an active screenshot of a short trade I entered on March 4th. This was a trade on the Dow Jones Futures (YM). If you are unfamiliar with the concept of “Shorting” then please click here for a quick lesson from our StockAbility StartUp to get you up to speed. Just know this, when you are shorting a market, you are aiming to profit when the asset goes down. In this example, I was short the YM from around the 31300 with a target at the lower area just below the red line, a price of around 31,000. This is around midway in the trade:
The interesting aspect of this trade is that I had already taken a few losses earlier in the day. That’s right, this was not my first trade of the day. Part of my risk management system is to allow myself a set number of trades for day. These must meet my trade plan criteria. This controls my emotions, forces me to “pick my spots” where I enter and be patient with my targets. In the above trade, due to market volatility, I had a generous target according to the price charts and stuck to my plan. Things progressed nicely as the day moved on:
Around 30 minutes later the target was successfully achieved. The result was a solid winning trade. It was vital to make sure I took a profit that I set ahead of time. This is a tactic used to avoid any emotional urges to let the trade “run”. Greed can often set in when on a wining position, delaying the objective exit and running the risk of the market turning against us. There is nothing worse than giving back healthy profits because you wanted more. Sure, the market went a little further down than I thought it would, but that is often the case. We can’t nail every top and bottom day after day! No matter what some “experts” will tell us. If you stick to your plan, then that is a success in my book.
Eventually the day turned into a profitable one, as I managed to erase the earlier losses with that solid win. The results for the day went like this:
Notice the win rate was low, at 33%? However, the most important statistic of all, is the Average Win to Average Loss figures. This came in at +$991 to -$183 respectively. That is the true power of the risk to reward ratio at work. Anyone who focuses on win rate above all else, is doomed for failure if they ignore this major dynamic.
Trust me, it can be tough to hold out for the winners when your back is against the wall. It does get easier when you have the right education and have taken the time to develop your skills. Though even the most experienced and educated traders can and sometimes do get caught in the emotions of the moment. For this reason, I tend to work on other projects and often walk away from the screen when in short-term trades. This allows the plan adequate time to work out accordingly, whether win, lose or breakeven. Your results will always be a true reflection of your plan and actions, irrespective of what the market does from day to day. I hope this helps.
Be well and thanks,