Sunday, January 18, 2015

Reviewing your approach to risk

It is said that a week is a long time in politics. For those who traded the EUR/CHF last week, 10 seconds was a lifetime.

No doubt further stories will surface over the upcoming days and weeks. But, as we have already seen, some foreign exchange trading platforms or brokerages have already announced their insolvency due to significant losses. In addition, there are hundreds, if not thousands, of individual traders who's trading accounts have been blown up.

It is the speed and magnitude of the price move that has caused all the issues. I’ve seen tweets about experience traders, using very small amounts of their equity per trade, losing all their trading account and ending up owing substantial amount to their brokers due to the massive slippage encountered in processing orders.

From scanning across social media this weekend, it seems that literally a few cents difference in your order and stop levels, will have either saved you or caused you massive losses. People whose stops were just above the 1.20 level were filled pretty much with no slippage. Just below that level, however, was a completely different story.

It is not just people who were betting on the continued support at the 1.20 level who suffered. I've even read stories of people who had bet on that level being broken, but due to obtaining poor fills on their orders, and then a subsequent sharp pullback, margin calls were being issued.

As a result of all this, there will be lots of traders reviewing their approach to trading and the level of risk they are prepared to take. I know I am, and its rare that I trade forex. Some questions they would be considering:
  • Was this a once in a lifetime event, or could another event like this happen again, and if so, how soon?
  • Do I want to trade markets/instruments where such an artificial price limit has been imposed or introduced?
  • Do I want to trade instruments where such levels of leverage are available?
Rolf at Tradeciety summarised some other considerations for individual traders in this post.

Thinking out loud here, one also wonders whether all the HFT algorithms and the like used by major institutions exacerbated what happened, and whether there may be limitations on such trading programs imposed in the future.

Any trader’s principal thought should always be preservation of capital. Risk control is not the most exciting topic to the majority – focusing on entries and exits appears to be more interesting. Yet, it is your overall approach to risk control that will determine whether you can achieve long-term success. It's pretty much a given that a lot of traders, particularly in forex markets, will have become a lot more risk averse over the last few days.

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