Last Thursday’s wild movement by the Swiss Franc wiped out a lot of Forex traders who were short of the currency. However, there were three things these unfortunate traders could have done that probably would have ensured their accounts survived to trade another day.
Let’s firstly be clear what really caused most of the wipe-outs in order to identify the potential remedies: the market moved so fast that stop losses could not be honoured, and were “slipped” by huge quantities, resulting in trade exits on far worse terms than anticipated. Traders not using stop losses found themselves unable to exit trades for several minutes, at a loss of approximately 14% multiplied by whatever true leverage they were using. Most retail Forex traders use true leverage of at least 8 to 1, which would have been enough to wipe out their accounts.
What could have been done differently to prevent those wipe-outs? What can traders do now to protect themselves from being wiped out by a sudden and huge fluctuation in the market?
Use Guaranteed Stops
Some brokers offer guaranteed stops. It comes at a price, meaning that if you want a guaranteed stop, you have to pay a higher spread and/or commission on the trade. Usually, even over periods of several years, traders using guaranteed stops on every trade will come off worse than traders using normal stops which might suffer from slippage. However, guaranteed stops do provide a protection against a “black swan” move in the market.
Lessen Risk: Lower Leverage
Most brokers offer very high leverage, but you do not have to use it. There are brokers allowing position sizes of 1 penny per pip. Professional traders tend to use no more than 3 to 1, which would at least have avoided a total loss of an entire account.
Question If a Currency is Prone to a Sudden Huge Move
It must be said, even in hindsight, that there were a few voices warning that the Swiss Franc could suddenly massively rise in value. This currency was being kept artificially weak by its own central bank, and was bound to strengthen dramatically immediately as soon as the Swiss National Bank announced its abandonment of its capping policy with mere words.
Trading all the time with guaranteed stops and very low leverage is probably too much for most retail traders to reasonably bear. However, it is possible to identify any currencies that are prone to a dramatic movement following a few words from its central bank, and trade those currencies in particular with guaranteed stops or very low true leverage.
The only major global currency that is likely to meet these criteria at the time of writing is the Japanese Yen. The JPY has weakened with the encouragement of the Japanese Central Bank. Were the JPY to suddenly announce that in its view the weakening had gone far enough and should proceed no further, it might suddenly strengthen by a fairly large amount, although it would almost certainly not be close to the huge 14% move by the CHF.
Prudent traders might decide to trade certain currencies only with guaranteed stops or very low leverage, or even to avoid them altogether. Unfortunately, a sudden and devastating act of terrorism in any major city, especially in a global financial centre, with a weapon of mass destruction, is something that cannot be intelligently guarded against. In any case, such an event would be likely to shut down global trade.
