This week has been the most volatile in the financial markets this year. Following a decline in Chinese stocks, global market reacted downward on Monday. The Asian, European, United States, and the Emerging Markets averages lost significantly continuing their losses on Friday. In addition, oil is now trading at the 30s and the bond yields globally suffered significant losses. The CBOE volatility index (the fear index) is now at a 1-year high.
To many traders, this volatility is the worst thing while to some, volatile markets are their cash cows. A good example of a company that thrives well in volatile market is Virtu financials which is a market maker in more than 200 markets. On Tuesday, the CEO reported that Monday was the most profitable day for them after the 2010 flash crash. In the flash crash, the major indices in the United States fell 15% as a result of high frequency market manipulation. Traders would place large trades and cancel them within minutes. This created large movements, up and down which led to buying and selling opportunities to the traders. How then do you make use of such opportunities to make profitable trades?
The key to make successful trades in highly volatile markets is on risk management. According to Douglas Cifu, the chief executive at Virtu Financial, the key to make a lot of money during volatile markets is on seeing the risks beforehand and expediting on risk management. This risk management will mitigate the risks of making huge losses in the event the trades goes against you. One way of managing risk is by putting a limit order. This limiting order allows you to buy slightly above the market price of a stock or ETF. It thus allows you to buying into the trend rather than against the trend. Additionally, by doing so, you have little chances of losing because many people who buy at the market suffer an instant loss.
For example. Suppose that PowerShares QQQ previously closed at 56.44. As a trader, you can buy and go long at 56.70 and then sell short 56.20. In this situation, if the market opens in the upside, you will get in and if it opens lower, you will sell short.
Another way of managing risk is through the trade size. A good way of doing this is to buy 20 to 50 shares of an Exchange Traded Fund (ETF). This allows you to make small profits or losses. Using large volumes can lead to serious consequences in a portfolio.
Last but not least, in managing risk, a stop loss comes in handy. A stop loss allows you to take a certain amount of loss to protect your account. The number you put should be calculated in accordance to the amount you are willing to lose.
Know when to walk away
The key to being successful as a trader is to know when to walk away from trading. When you reach your target, you might be tempted to continue trading. The end result will be catastrophic. One strategy to use here is known as cup-and-handle strategy. In this strategy, a stock or ETF falls and trades in a consolidated range. Afterwards, it goes back to the previous trading levels.
A good example is when shares of a company are trading at $70 and then falls to $50 and later returns to $70. After breaking above $70, most probably it will go up by another $20 creating the best opportunity to exit. At the same time, the stop loss should be at $50 which allows you to be safe regardless of the market movements. In addition, if the price of a stock moves at least 1% in intraday trading, you should not close it. This is because 80% of the time, markets tend to close in the direction of the high or low when there are big moves.
Another strategy to use is that of buying high especially when a good valued company reaches a 52 week high on good volumes. This is the point when institutional investors buys and increases their positions, thus pushing their prices higher. I recommend that you scan for companies trading near or at the 52-week highs and then place a trade. Chances are that the price will continue going higher as more institutional investors gain interest in the shares.
In summary, volatile markets are the most important for day traders because of the huge movements experienced. We saw that during the Greece crisis and we will see it in September regardless of what the FOMC decides on rates. The key to success is having a good plan and executing on it.