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Screenshot of a breaking news alert e-mail from Q2 2017
The following guest post is courtesy of Adinah Brown, content manager at Leverate.
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Your trading plan is the main template for every trading decision. Whilst plans are designed to take advantage of everyday trading opportunities, unusual situations that offer great potential profitability should be incorporated into the scope of every trading plan.
There are a few difficulties in trading an event, particularly a market shattering one. The first is that a really surprising event, in the likes of the Black Swan event of 2015, are highly unexpected.
The second main difficulty is the issue of how to trade the actual event. If the event is something that creates a new unexpected paradigm, understanding how the market will react, and particularly how the new paradigm defines the potential outcome is something that is difficult to gauge.
To use the unlinking of the Swiss franc as an example, the market reacted so suddenly to the news that it lost in excess of 30% of its value immediately, wiping billions off the market. All in one moment, several brokers lost in excess of their holdings and became insolvent. Those that were not, had difficulty paying out positions because the speed of the movement left doubt as to whether the positions could have been filled or closed. Trading was basically halted by most brokers, and it took days for feed providers and regulators to understand how the situation could have been better handled. In the end, many of those with positions in place to take advantage of the drop did not necessarily receive their profit, with their brokerage’s risk management tools automatically closing their positions, halting trading, unable to identify close or open positions and a variety of other reasons. And many of those who traded with an insolvent broker also lost, as there was no one to pay them out.
Whilst this was an extreme example, it serves to highlight the risks involved in a black swan type event.
Other trading events, though not on the level of a black swan, but more like the bursting of the dot com bubble or the GFC, or paradigm shifts like the emergence of bitcoin in 2013, provide excellent trading opportunities and a much more stable capacity to recoup profits.
Everyone has a different plan and style of trading, so providing advice on incorporating it into the plan is a bit tricky. But a significant market event will generally not fall within the trading rules set out in a plan designed to trade in regular market conditions. The entry criteria are likely to be completely different for an event, and thus some thought needs to be taken into account as to how to identify the entry point.
In addition, the market behaviour during a significant event is generally different as well, meaning that the exit criteria are also unusable.
For those who are technical traders, it might be difficult to identify the reason for the event without understanding the fundamental elements. This in itself might be a challenge for many technical traders. For a fundamental trader, understanding the reasons might not fully give an understanding of how the market is likely to react without studying the technical indicators and chart activity.
The best method for creating a new plan for an event is to go back to previous events. Start by seeing how your regular entry plan works with the event and where it was not able to be used. If your regular method or indicators provide you with insight into how to trade, then use them. If they need modification to address the different market conditions, modify them whilst remembering to supplement your entry plan with an extra set of requirements which determine that an event is actually occurring. If they don’t work, find ones that do and use them.
Then do the same for your exit strategy.
Ultimately, it is important to analyze historical market activities at significant market events, so that you will understand them and be able to trade them successfully. One eye on the market calendar or those economic indicators will then give you some warning when the next profitable event might occur.