Prior to the last recession, there was a sharp increase in exchange rate volatility. Fast forward three years and, once again, we are witness to another obvious uptick in currency price instability. This time around, factors such as the Eurozone debt crisis and the resulting flight to the safety of the dollar have served as the catalyst triggering the volatility. For currency traders, lessons learned from past experience should be top of mind now and the primary goal should be preservation of account capital.
Foremost in this list of lessons is the need for a risk mitigation strategy. All trading activities should be guided by a plan that minimizes, as much as possible, the potential for over-sized losses. During times of increased volatility, the need for risk strategy is even more critical as losses can quickly become magnified to the point of compromising your entire trading account.
One of the first things to consider when updating your risk strategy is to re-evaluate your use of leverage. Lowering your leverage when volatility spikes can reduce losses, but it also lowers potential gains. Given that the main goal at this time should be capital preservation, most traders should see this as an acceptable trade-off.
On a related note, instances of greater volatility also elevates the risk of a margin call. As volatility increases, the speed with which your account can fall into margin trouble rises dramatically. To prevent a margin call, you must keep a close watch on your account’s margin status. You may also consider increasing the capital in your account to provide greater margin headroom to allow for wider price swings.
Determining price trends becomes even more challenging during bouts of higher volatility. For those trading in the OANDA market there are several tools available that can help gain a clearer picture of overall market sentiment. The OANDA OrderBook for example, shows all current positions for each currency pair as well as all pending orders for each price level. With this information it is possible to determine possible rate trends and even potential support and resistance levels.
Keep in mind that as long as you have an open position, you are exposed to market price changes. If you cannot actively monitor your open positions, you are at risk of the market price moving against you. To limit losses to manageable amounts, it is imperative to include stop loss instructions for all open positions.
