The markets are driven by sentiment. Investor sentiment is made up of the emotions of people who are trading the markets. Sentiment can change at any time, via new information. Some times the information is expected, and sometimes it comes as a surprise. The key to dealing with either expected or unexpected news is to determine whether your risk profile has changed and how you will handle the new data.
The price of a security, exchange rate or any asset is valued based on all the available information. When new information is released, the price of an asset might change to reflect that new information. For example, the value of Apple might change after the company releases its financial results. If better than expected guidance for the company is provided, the stock price might rise. This type of information is scheduled and this allows traders to prepare for new information.
But how do traders handle new information that was not expected? During the first week of May 2019, President Donald Trump tweeted that he would increase tariffs on China if they did not come to the table and iron out a deal. China had started to backtrack on some of the concessions they had made, and it became evident when they sent a draft to the white house. This information was not expected and in fact, many believed that a deal was imminent. Stock prices swooned on the news, and the Chinese Shanghai market tumbled 5.5%.
How to Manage Risk
When an unexpected event occurs, it can roil markets and generate significant volatility. Online forex trading can become very volatile. During the first week of May, not only did the Chinese stock market tumble, but the US markets also dropped. Volatility surged more than 20%, which means that traders were scared of additional declines in stock prices.
In a situation were you know in advance that there is a catalyst that can drive price action you need to control your positions. You can either exit completely before the event, or hedge your bet using options or another security. You can also reduce your position to a size where you can continue to benefit if the trade moves your way, as well as, withstand an adverse move.
Dealing with Illiquid Periods
One of the reasons the Chinese markets tumbled was that the news was unexpected. It also occurred over the weekend, making it difficult for anyone who had a position to exit. What you need to account for is markets that are illiquid regardless of the position you are holding. If you decide to hold a position overnight or over the weekend, you need to determine the historical maximum one day change in the value of the security and determine if you are comfortable holding this position if an adverse move occurs.
New information that is unexpected happens more than you might believe. Every time you take a position you need to determine the worst possible scenario, and the chance that it occurs. This will help you determine your position size, and allow you to trade another day.
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