From Brexit through to the Coronavirus pandemic, high levels of volatility in the currency markets have become a familiar sight in recent years. With extreme highs and lows come abundant opportunities to make substantial financial gain. Yet with this comes great risk. Dáire Ferguson, CEO at AvaTrade, explains how traders can profit from market volatility without jeopardising their assets
Every good trader knows that greater levels of market volatility equal greater opportunity for profit. The foreign exchange (FX) market, for instance, can be incredibly lucrative when navigated well – with 24/7 trading possibilities and regular fluctuations on major currency pairs allowing traders to net a handsome profit.
Naturally, in times of higher volatility, it is not only the scope for profit that grows significantly, but also the potential for loss. Coming down on the right side of the two is a question of balancing risk and reward. This can be a tricky calculation, but there are tools on the market – such as investment protection and options trading – that can help minimise the likelihood of loss significantly.
Market volatility
We need not look far for examples of extreme market fluctuations. The past five years have been dominated by significant and unpredictable political and social events, prompting strong and frequent reactions from markets.
In 2016, both Brexit and Donald Trump’s election triggered widescale political disruption in the UK and the US, creating the perfect climate for traders with the foresight to profit from the resultant peaks and troughs in the GBP/USD.
Since then, ongoing US-China trade wars and increasing protectionism have further rocked the boat, and – more recently still – the global COVID-19 pandemic has meant that sterling has suffered extreme fluctuations, hitting a 35-year low in March of this year.
Over the course of these events, we have seen highs and lows in currency that a shrewd trader could convert into significant profits.
December 2019 saw Boris Johnson achieve a majority of 80 seats in the House of Commons on the day of the results of the general election, leading the GBP/USD to reach a high of 1.3114, yet this quickly dropped 11 days later, following the Prime Minister’s ruling out of an extension to the post-Brexit transition period, with GBP/USD reaching a low of 1.2904 on the 23rd December.
Moving into the new year, the UK announced its official exit from the EU at the end of January, and GBP/USD held a steady range between 1.2950 and 1.3200 up until the coronavirus outbreak.
At this point, the global introduction of increasingly stringent measures to combat the spread of the virus saw the FTSE 100 plunge by over 8% – the largest intraday fall since the 2008 global financial crisis – on the 10th March. In addition, the Bank of England cut rates to 0.25%, the lowest level in history.
Resultantly, on the 19th March, GBP/USD reached a 35-year low of 1.1410 – a drop of 0.18 compared with highs earlier in the year – before recovering slightly as negative news about the escalation of the pandemic in the US lowered the value of the dollar. Currently, the GBP/USD rate holds a range between 1.2070 and 1.2600.
The above fluctuations give ample scope for profitable trading. Someone selling GBP/USD on the day Boris Johnson was elected, for example, would have stood to make around a 13% profit on their investment if they then bought it back ahead of the Bank of England announcement on the 19th March.
Alternatively, had they purchased GBP/USD at the height of bullishness surrounding the Johnson election, expecting further gains, they would soon have been hit first by the rising prospect of a no-deal Brexit and then by the onset of the pandemic in the UK.
Retreating back to dollars in March ahead of the Bank of England announcement (in fear that the pound would continue to plummet) would have netted them a double-digit loss. Timing is critical, but foresight is not always possible. Given the unprecedented nature of the current situation, we could still see more extreme drops – so making sure risks are contained where possible is key to success.
How can we trade safely?
While even the savviest of traders can fall victim to a sudden drop in currency price, there are measures that can be taken that limit downside risk, making this type of trading much more accessible to the wider public.
One approach is to use a risk management tool to protect your investment. Commonly used by fund managers, this type of product is still relatively new to the retail market, but it can give traders of all kinds the flexibility and support to trade with confidence in riskier climates.
AvaTrade’s risk management product, AvaProtect, for instance, gives clients the opportunity to purchase total protection against loss for a defined period once a position has been opened.
As a result, no matter what direction the market takes, traders are safe in the knowledge their trades have been protected for the period they have opted to cover them for.
Options trading also offers more sophisticated ways to hedge risk, with traders buying and selling of financial contracts that allow the purchase or sale of an underlying asset for a certain price within a set period of time.
Traders can either buy a call option – giving them the right to purchase an asset at a given price – or a put option, entitling them to sell at a given price. Rather than committing capital up front, the only exposure a trader takes on is the premium charged to buy the option.
If, after buying an option, the market does not move in the direction it was expected to, the trader does not have to invest the rest of the capital they put on the trade, giving them far greater flexibility and cutting potential losses.
As such, profiting from market volatility can be made safer and more accessible with the right knowledge and tools. With more and more forex trading platforms coming to market every year and the technology they offer constantly evolving, new features are constantly emerging that can make it easier for traders to capitalise on their convictions and seize opportunities without overcommitting. The result is that, today, even relative newcomers to the market have access to the tools and support they require to trade with confidence.
Originally published on globalbankingandfinance.com