While many traders love volatility and need it to trade in their timeframe it creates as many risks as it does opportunities. If you are on the right side of volatility you can make a lot of money but being on the wrong side will cost you dearly.
Here are the top 10 dangers that traders and investors face during times of high market volatility.
- Volatility can trigger a stop loss to only have it reverse and go back in the favor of your old position. Stop losses are still crucial for traders to keep losses as small as possible.
- Losses can be larger than expected as moves can be many times larger than expected based on historical volatility even when using usual position size parameters. When volatility is twice as much as usual half position sizes are safer than your normal position size.
- Gaps in price action can cause stop losses to be missed and larger losses than expected.
- Volatility can mentally exhaust you and cause traders and investors so much stress that they stop trading or investing at all.
- Volatile price action can cause traders to have style drift into time frames and systems that they do not usually trade and do not have an edge in.
- If trading both the long and short side of the market you can double your losses by being on the wrong side of the market twice as it moves quickly in both directions in a short period of time.
- Option writers can have losses far bigger than they thought possible as a price moves several standard deviations in a short period of time.
- Option contracts can be so expensive that the passing of time and the expiration date can cause large losses if a move doesn’t happen fast enough for option buyers.
- Volatile markets can cause large trading losses and big drawdowns that are hard to come back from as the math works against you. If you lose -20% of your capital you need a +25% gain just to get back to even.
- Investors that get out during volatile price action and go to cash don’t know when to get back in and miss the next big run up in price.
