How to trade in high volatility? The Real Story

In order to avoid losses during the volatility jumps, it is very useful to adopt the correct attitude to trades. You should learn one very simple to understand but very difficult to use rule – you should always open a trade with a thought that you may be absolutely wrong.

Taleb gives an example of the Wall Street legend, billionaire George Soros, who learnt to change his opinion easily without a shadow of doubt. Sometimes, his inconsistency confused his subordinates during meetings. Moreover, he always likes to underline that he often makes mistakes. This ability helped him to survive in the market whirlpool and become one of the richest men on Earth.

“The lesson I learnt from Soros is to start every meeting convincing each other that we are a set of idiots who do not know anything and are subject to mistakes, but we possess a rare privilege to know it”, – the words of a man who knows Soros.

I blew up my deposit in 2014 not because I didn’t know that it was dangerous to trade against a trend. I faced the situation, which I call the ‘wrong decision loop’ in the event of the volatility splash. I relied on my experience in trading. There were no situations in my memory that the rouble may crash 2-3 times, from which I made the erroneous conclusion that it wasn’t possible at all. Moreover, I didn’t have a willpower to timely recognise my mistake.

Only after suffering the most overwhelming defeat in my life, I gained freedom from erroneous decisions and practically pulled myself from the emotional pit. I had to string myself up to pull through the antipathy to the market and start investing again.

Here are three life-hacks for the 2020 crisis, which are based on the experience of many traders. At some point they helped the writer of these words to change the attitude to trading and to start making money again:

1. It is better to read books than to make losses. Volatility splashes often result in anomalous behaviour of financial instruments. No doubt, there will be situations when it would be difficult to believe that such a crash is possible at all. The exit from all positions and temporary refusal to execute trades help a lot. This approach allows preserving the capital for the future and saving a multitude of nerve cells.
2. Learn to think in the long-term manner. Statistical analysis shows that only a few survive in the strategies of high acceptance of risks, especially when the volatility grows. You shouldn’t accept the behaviour of bold spirits in the market as heroism. Very often a temporary success is caused by pure luck. On the contrary, the one who intends to run a long distance will achieve significant financial successes with a higher probability.
3. Psychological practices. Meditation and other awareness improvement techniques really allow developing a quiet attitude to the market travails and avoiding the tilt. It is a very useful quality for a trader.

Risk management is the ability, without which you cannot survive in the market for a long period of time. In the absolute majority of cases, traders make losses not because they trade badly, but because they cannot control their risks. The risk management rules should be made stricter in the times of high volatility, while many traders make a mistake by reducing them.

I have never used leverage in the relation bigger than 1 to 2 and never tried to trade against the market after the painful blow up in 2014. The lesson was learned. Moreover, my priorities nowadays are long-term investment strategies and only once in a while I am engaged in speculations.

Although, it should also be noted that, by themselves, short-term strategies are not bad. They bring money to many traders. It is important how proficiently you can keep discipline, being in the market every day.

Here’s one illustrative example. In the event of the growth of the standard deviation of the price from the average value from 5% to 15%, in relative numbers, the risk grows disproportionately. The risk management rules, which are applied in the inactive market, cannot be applied in such a situation. For example, you usually trade aiming at the potential risk to reward ratio in every trade of 1 to 4 and higher. This difference allows you to cover even several loss-making trades in a row with one profitable trade.

However, the traders know well that high volatility creates conditions, under which stop losses are constantly ‘knocked out’, the market becomes ‘thinner’ and traditional levels cease to work. The market as if ‘enters into a collusion’, sneaking up to the most distant protective orders. And a trader has either to enter the market more often or shift stops. The former is fraught with the growth of emotional load and getting into the wrong decision loop. The latter may lead to the drop of the reward-risk ratio to 1-to-2 or even 1-to-1. A series of 4-5 loss-making trades with a leverage would be sufficient to have a disastrous impact on your deposit.

I would recommend the following to the traders in such a situation:

1. Do not use leverage until the volatility returns to the average values.
2. If you cannot keep the risk-reward ratio during trading, take no chances and go away from the computer monitor.
3. If your strategy allows it, do not rollover your trades overnight. Morning gaps, when you cannot undertake anything, produce the biggest risks in the volatile market.

It is not an exaggeration that a big crisis is a big luck for a trader. It is really so. The earlier you manage to learn the lessons of self-control and risk management during the volatility jumps, the more money you will preserve in the future. The writer of these words meets the 2020 crisis without major emotions and shock from the market fluctuations. It really transformed into a good investment opportunity rather than a threat for the capital.

Good luck trading!