This article was written by Richard Perona, VP of Institutional FX at Advanced Markets.
Major market events are generally accompanied by periods of massive uncertainty, volatility and downright fear. It doesn’t matter whether these events are expected, like the Brexit vote, or unexpected like the SNB move last year, the outcome is the same. Many market participants have a few options on how to survive the dislocation. Fear of the unknown creeps into every financial exchange, instability reigns and price action is violent. These events has the potential to affect every trader, brokerage and bank for days, weeks and even years depending upon their severity and the resulting market fallout. Below, I will outline a few possible risk/reward strategies along with how to attempt to control the uncontrollable.
RISK / REWARD for participants:
Manual Traders –In a “known” event, where planning ahead is possible, some brave traders could either take the long term view hoping the outcome goes in their favor or they could try to capture a lightning fast move during the event itself.
- Risk – In reality, anything can happen as outcomes are never set in stone. A potentially massive loss, possible hefty slippage getting into the trade, negative balance
- Reward – A possible massive profit
EA / Robots – The algorithmic programs (algos) continue to trade away while the market swings violently
- Risk – possible massive capitulation causing the algo to go into somewhat of a meltdown (stop loss with possible hefty slippage)
- Reward – possible massive profit
Sideline Traders – this group has either completely hedged their positions or have no positions at all
- Risk – Missing out on a potential market move
- Reward – Not exposing your account equity to massive fluctuations
The unruly even- driven market leaves little doubt that every account could be at risk. So, if one cannot control the market then at least try to control the environment on which one trades. The following are some suggestions and recommendation on who is best suited to weather this BREXIT-type market event:
1. Only use a well-capitalized brokerage, one that can withstand the volatility and endure a possible “worst case” scenario
2. Use TriParty Custody Accounts, (a bank account in the client name)
- If unsure, inquire about “true” segregation of your funds, then you don’t have to worry about other traders negative balances possibly eating into your funds.
3. Only use an STP Brokerage that has multiple large global banks as Liquidity Providers and who can readily handle this type of move
- Some B-Book brokerages will be more than happy to ensure your Stop Loss is met during the chaos.
4. Ask your brokerage what steps have been taken to prepare for a major event, such as BREXIT:
- Did they Reduce Leverage on, for example, EUR and GBP related instruments?
- Did the add Extra Support to handle the BREXIT vote?
- What have they done to prepare for a situation where some accounts go into negative territory?
- What happens if the technology fails? How do I exit a trade?
5. Only use PROVEN, STABLE technology. Meaning that if a bridge, with all fancy bells and whistles, is overloaded with orders and without the necessary bandwidth and robust infrastructure to handle that flow, then most likely it will crash and you will be at the mercy of the market.
A major market event, such as the one we are currently dealing with, BREXIT, could come as a massive shock and result in capitulation and chaos. Most traders remain on the sidelines to live another day, but a risk still remains with your brokerage. Time will tell who those brokerage firms are who were prepared to take these types of event in their stride. Those brokerages who took the short cut in their set up and preparation and will potentially be left underwater. As Warren Buffet said, “Only when the tide goes out do you discover who’s been swimming naked”.