Recent events have shown many forex traders just how destructive the markets can be when they move unexpectedly very rapidly to cause slippage and widespread losses. The uncapping of the Swiss franc against the Euro caused one of the largest single day major currency moves of the past 50 years. This sudden move caused the Euro to plunge and meant that those who were holding long positions in the EUR/CHF would have faced large losses due to the large amount of slippage caused when price nosedives in this way. Whilst this is an extreme event, it is a timely reminder for many forex traders that volatility needs to be taken in to account, perhaps to a lesser degree to this event, in day-to-day trading.
The cause of volatility in forex trading
Volatility occurs when markets become fearful, or when certain events cause either a general surge in the buying or selling of a currency. Uncertainty is something that forex traders dislike in these situations and during periods of volatility it is common to see the value of safe-haven investments and currencies, such as the US dollar, appreciate as traders look to avoid volatile markets. For intra-day traders there are two forms of volatility, that which can be anticipated and that which cannot. For the first of these, many forex traders will ensure that they are aware of large news events which could potentially increase volatility. For the latter, there is not much which can be done but to ensure that stops are strategically placed to limit losses if the market turns against a trader.
It is often difficult to segregate those news events which can be foreseen as creating volatility it is easier to pinpoint those which could potentially cause volatile market movements. There are several events which forex traders can instantly identify as causing all currency markets to move, which include the data releases of key economic indicators and interest rate decisions.
Volatility caused by known news events
The most notorious of these occurs on the Friday of each month as the US employment figures are released to the markets. Regardless of whether these are in line with expectations or shock figures, they always cause a volatile price swing during and immediately after the data release. For this reason, many forex traders avoid trading immediately before and after this event, with volatility tending to disperse an hour or so after the data has been released. Other traders adopt more protective strategies, such as smaller position sizing and stop losses set behind key areas of support and resistance in order to allow the stop to be triggered with limited slippage. Since slippage occurs when price moves too quickly for an order price to be executed, it can be particularly useful to break the surge in price.
The impact of interest rates on forex markets
Other key events such as interest rate decisions are a favourite for new traders but can be dangerous for those looking to trade without a stop-loss. As surprise interest rate decisions cause currency markets to move sharply up or down, often without consolidating to their original levels, these trades can be considered a gamble without a risk management strategy to cut losses in the event of a losing trade. Unlike large institutions, most forex traders do not have the financial resources to trade their way out of a losing position over several days. Cutting losses early, and the positioning of stop losses which confirm that a trade has failed to limit losses to a small percentage of the trading account, are often the best ways to manage trading in potentially volatile markets.
Trading with guaranteed stop losses
For those news events which occur spontaneously, it can be very difficult for forex traders to avoid the subsequent market volatility. Depending on the risk to reward ratio being employed in a trading strategy, some traders may be able to protect all of their positions by using the guaranteed stop-losses offered by some forex brokers. These stop losses should be honoured by the broker, even in the event of extreme market moves as recently experienced, and can be a useful tool for those traders who are willing to pay a slightly larger spread in return for this guaranteed security.