Each trading day is marked by a wide and even bewildering range of financial events, making it a priority for beginner Forex traders to consistently stay in touch with reliable news sources and expert consensus opinions.
Amongst other things, reading the financial news helps to understand the direction of an economy and national currency. Similarly, stock exchange investors can keep up with the developments in publicly listed companies. Those who favour this type of fundamental analysis may often partly base their trading and investing decisions on new developments, and it’s important to pay equal attention to risk management.
Risk management is an excellent way to adapt to ever-changing market conditions in which there’s no such thing as a sure thing. If you understand this from the beginning, it will help reduce the stress that may come with trading and investing in what is essentially a future outcome. Yes, there are historical records that make asset movements more transparent, and charting techniques that use statistics to predict and model the potential direction a price may take, but what happens when the outcome is unexpected?
Expect the unexpected
The secret to risk management is to expect the unexpected.
To illustrate this in more detail, let’s take a scenario in which the UK is about to report its latest quarterly Gross Domestic Product (GDP) results. When researching the possible outcome, you might come across different market consensuses from ratings agencies like Moody’s, or analysts’ consensuses gathered by news agencies like Reuters and Dow Jones News. In addition, government agencies issue annual growth forecasts which are used as a basis for analysts’ calculations. Examples of market consensuses can be seen on our Forex calendar which is available on Admirals website.
As you can see, there’s no shortage of market opinions to base your decisions about trading the Pound Sterling during the UK’s economic growth results. While a great deal of expertise goes into the market’s anticipations and the results can be accurate, there’s always the chance of a deviation from expectations.
If the market consensus was for the UK’s economy to have grown by 2 percent in the second quarter and the actual result was 1.95 percent, it is enough of a deviation to trigger concerns about the value of the GBP in the Forex trading community. There may be a sell-off in the currency, meaning that even though you were expecting a 2 percent growth and opened a position for the GBP to rise accordingly, the currency fell because the actual result was lower than expected.
Setting stop loss levels
There’s little doubt that the solution for this type of scenario we’ve talked about above is to always set a stop-loss so you’re not caught out if there’s a sell-off when you were expecting the opposite. Just as there are many opinions about the outcome of a trading or investing event, there are as many opinions about where to set your stop loss levels.
One school of thought holds that the most effective technique is to set a stop-loss level that’s not too far away from your entry position in case of anything unexpected, the idea being to exit the trade as soon as possible. Another approach is to set the stop loss based on a specific percentage which reflects your risk appetite. A third approach is to check the last support level for the instrument and set the stop loss in the same area.
Hedging your position
The principle of hedging involves looking at a trade from different sides. Suppose that the Non-Farm Payrolls (NFP) announcement is tomorrow, and the market expectation is for the report to show strong growth in the US employment market. It’s a fair assumption that if the actual results are in line with the market’s expectations, the USD might rise.
On the other side of the coin is the possibility that the results might fall short of expectations.
Gold and the USD are inversely correlated, meaning that if the USD rises, spot gold prices often fall because these assets are seen as safe-havens and used as international reserves. The USD is favored when the US economy shows signs of growth, as in a strong labour market. In this situation, a trader may decide to hedge their USD trade by taking a position on gold using a CFD in their Admirals trading account.
In this scenario, a hedge would be to take a long (buy) position for gold and the USD to rise and include a stop-loss on both underlying assets. If the NFP numbers are lower than expected, the USD may fall, and the trade would exit at the stop-loss position. Meanwhile, the gold instrument may rise as traders switch their safe-haven risk appetite to the precious metal, and the trade could perform as expected.
As you can see from the examples above, trading takes research and know-how and at Admirals we have an infrastructure in place with the educational resources, webinars and market analysis you need to get started.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
