Survival Tips for a Stormy Market

Note that I wrote this article in late 2008 when the market turmoil was in full swing.

We are experiencing and will continue expecting major volatility over the coming years. And volatility can lead to savage drawdowns with stocks dropping more than 30%. For this reason recognising the effect of high volatility is of paramount importance in today’s markets as otherwise you are unlikely to be able to take advantage of the great profits on offer over the next few years.

For roughly the last 12 – 18 months the markets have been in a period of very high volatility. Many markets are currently trading at around twice their historical mean (some more and some less, but double is a rough guide). The usual measure of volatility is the range that a market makes on any particular day. There is a specific formula for this calculation which we won’t go into here, but the most frequently used measure is known as ATR (average true range). If we look at ATR over 2 years ago (from the same week in January 2007) to today for different sectors you will see what I mean.

Volatility
	2007	2008
Wall Street	98	286
Euro/USD	90	280
Gold	10	22
Cocoa	32	116
Crude Oil	179	253

Remember what while bullish periods typically start when most investors are pessimistic and usually last a whole lot longer than most people expect whilst bear trends are more savage but tend to end much quicker than seems initially apparent.

What this means as far as our trading is concerned is that we can expect approximately twice the volatility in each market on a daily basis, so consequently when a market starts to break out from a range and a trend develops it’s not going to go up or down in a straight line (markets don’t anyway) but is going to move around a lot. This volatility is tough to handle from an emotional perspective as it’s like riding a rollercoaster.

Tips and Tricks for Trading the Volatility -:

But what is the best way to trade spread bets when markets are extremely volatile?

1. Stay calm and resort to clear valuations on likely profits, sales…etc.
2. Identify those shares which have been oversold and are now at very low P/E, or whatever your favourite measure.
3. Consider investing IF you can see they will survive, have clear repeat business and demand…etc.
4. In these volatile times it is especially critical that you keep your margin percentage low at all times (say < 35%). Otherwise, even if you get your research right and correctly predict the trend of a particular share, there is still a good chance that volatility will blow you out of the water (stop losses kicking in, margin calls/underfunding or pure surrender caused by panic). Using low stakes is also a good idea especially for your initial position (at least then you can stack up additional positions if the trend goes against you). Lastly, it is critical that you understand the instrument you are trading (and what losses it could generate) - for instance a 50 pence bet on Oil sounds cheap, but with fluctuations of up to £10 this week could have cost you £500...
5. The increase in volatility means that instead of trading a larger amount for a shorter period, you can trade for the same period with smaller amounts and still reach your profit targets. In these turbulent times it is not uncommon for a share price to move up to 5% or more in a day and a spread bet with a minimum margin requirement of around 10% would gear returns by up to 10 times. Also, trading smaller stakes in such markets means that one or two losing bets won’t knock you out for the day or the week. The key here is to know your markets and exposure and to manage your risk.
6. Resilience. When you are wrong in these markets you can really be (painfully) wrong. Successful traders are quick to recognise when they’re wrong and play defense, even as they look for opportunity. By managing risk you are also effectively managing your emotions and staying in the game. Volatility can shoot through the roof during a crisis, increasing the need for tools like stop loss orders.
7. Limit the number of trades you make. Difficult markets do bring excellent buying opportunities for the medium term, although one needs to be selective and patient. Don’t be afraid of missing moves; you need to wait for clear signals and good reward-to-risk opportunities, if there is something in this market is that opportunities abound.
8. Remember this is not the time for panic, although it is a good time to be taking advantage of others’ panic resulting from irrational or forced selling…
9. Try to insulate yourself from external factors and distractions – It is difficult to focus on trading if you are worried about unemployment or loss of income/savings; protecting your personal finances helps maximize focus during trading.
10. Of course, to take advantage of these opportunities you do need to either retain some cash, have the ability to switch from other assets or make use of unused borrowing capacity (for those few clients who have the tolerance for gearing). And you should not expect the benefits to arrive from such buying immediately. Cheap shares can always become cheaper so it makes sense to stagger your entry.
11. Don’t hold waiting for a big positive news event, if it disappoints you’ll be shafted, and if it delivers, it was probably already in the price at the close the day before.
12. And keep in mind that during volatile markets it is not possible to get out of small caps quickly!
13. Stop losses and getting arbitrarily stopped out due to spikes, I agree this is frustrating. Way round this problem is to make sure you have enough funds in your account so that you don’t have to set stop losses too tight, avoid trading at the start or end of the day as the spreads widen a lot (admittedly difficult when rolling overnight but I have started widening my stops on rollovers), and not having automatic ones but applying them manually (if you are able to keep track of the market, of course…).
14. Make sure to take your profits at some point especially in those volatile markets – traders often neglect this only to find themselves dropping in the red again!
15. Remember, volatiliy is a positive trait for spread betters allowing us to take advantage of larger-than-normal moves in the share prices of big companies. But if the volatility persists it could have a detrimental effect lowering confidence in the markets – unlimited volatility at some point ceases to represent a trading opportunity and starts to represent chaos. Be prepared to sell for a loss to buy back later, rather than just averaging down if things keep moving against you.
16. Lastly, do not ignore your personal health and well-being so don’t be afraid to to step away from the screens – it is easy to get burnt-out when you are continually following the markets with a consequent drop in concentration and bad decision making.
17. Having spent a lot of time looking back at charts in the last bear wave, so many trade traps, high volatility and false bottoms…etc. Most of the usual methods traders use to analyse the markets are out of the window, well timed small ‘tip toe’ steps is the only way at the moment imo with tight risk controls too!
18. Remember that in times like these capital protection is number one, the market owes nothing to anyone and doesn’t care how much dosh one loses (or makes), no one can blame anyone else or the market for the results of one’s trading decisions. We can only do our best and at times the best thing to do is do nothing (or very little with very low risks).

British Army officer and renowned explorer Sir Francis Younghusband once wrote: ‘…to those who have struggled with them, the mountains reveal beauties that they will not disclose to those who make no effort…and it is because they have so much to give and give it so lavishly to those who will wrestle with them that men love the mountains and go back to them again and again…mountains reserve their choicest gifts for those who stand upon their summits.’

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