Trading Safely in Volatile Times

04/19/2011 2:00 pm EST

Focus: STRATEGIES

Brian Dolan

Chief Currency Strategist, FOREX.com

Trading in high-volatility conditions requires certain adjustments, and FOREX.com's Brian Dolan advises reduced position size and a more defensive posture.

Joining me in the MoneyShow.com video network studio, Brian Dolan. Brian, in the face of all the uncertainty and the headlines and the actions that we see overnight, what type of risk management tools can you recommend for traders and investors?

Sure. My starting point for risk management is position size. That is the ultimate determinant of how much money you're risking. 

Given the volatility, we've got the unprecedented developments in the Middle East, natural disasters taking place in New Zealand, Australia, and elsewhere. There are any number of surprises that can hit. 

We're moving into a higher-volatility environment, so my first recommendation would be that traders generally scale down their position sizes. It's going to give you more staying power in an adverse move, allowing you to perhaps average in at some better levels.

As news hits the market…because a lot of what we've seen is surprising news developments hitting, the market reacting for a relatively brief fashion. So there's a lot of opportunity with that volatility, but you're not going to be able to take advantage of it if you max out your margin, if you max out your position size. 

So I think keeping your position smaller, I think trading on a more defensive stance is also in order.

So again, we're looking at a lot of the safe-haven currencies; the swiss franc, the yen. Then some of the commodity currencies, aussie and Canada, looking to buy those on any kind of a pullback.

Any other risk management strategies you can recommend?

Over the last couple months, we've built ourselves into a range in a lot of different currency pairs. So I think now more than ever, you really have to be aware of those ranges, be alert for a break out of those ranges. If and when—the ranges always break—once they do you have to go with that breakout. 

It's not a time to wait for a mean-reverting position to come back and for the range to reassert itself.

You look throughout the world and there's any number of fragile economies out there among the majors. The risks on the downside are much greater, I think, than any sudden rapid improvements in these economies. 

So that again is why I'm focusing on the safer-haven currencies. The metals as well look also to be—at the current levels above 1400 in gold—probably not that attractive. If we see it back in the mid-1300’s, that might be an opportunity.

Daytrading opportunities particularly because of the unrest overnight, would you stay short term or for those that are still looking to buy and hold, would you recommend something else?

I think there's an opportunity for both styles in this environment. Short term obviously being driven by the news headlines, and you're going to get some very quick reactions.

On any number of days, we've seen a good 200-point move down in the euro followed by a 200-point move up within 12 hours. So that is a very target-rich, short-term trading environment.
 
Looking farther out, the longer, the medium-term traders, I think we're also at some pretty significant levels in terms of the British pound, the euro. 

Again, my view there is that we're going to see weaker euro and sterling prices going forward, but while we have this strength, that represents, I think, a medium- and longer-term selling opportunity. So I like to use whatever uptick volatility gives us as a selling opportunity.

You mentioned gold, surprisingly, it is not reacting as one might expect to some of the overnight political actions. What is that telling you?

It's telling me that it's reverted more to a commodity trade and not quite as much of the safe haven.

Silver is another example there. Silver has outperformed gold on the upside, and that suggests that's more of a commodity situation than a safe-haven play.

So I think investors and traders need to keep that in perspective and treat gold as a speculative commodity and not some magic safety valve.

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