Financial headlines are ramping up their complaints about the levels of uncertainty and risk that are pervasive in today’s markets. If only President Trump would provide details for his tax reforms, stimulus programs, and growth strategies? If only political risk would subside across major countries in Europe? If only regulators would back off their repeated attacks on forex brokers? If only…
Unfortunately, for every “If only” that disappears, it seems that two more jump into the picture from nowhere. We do live in uncertain times, and all forms of risk, from political to systemic to whatever, are creating an uncomfortable trading environment for all of us. No one is immune. Forex brokers are dealing with an avalanche of assaults from regulators across the globe. Financial markets cannot make heads or tails of what populist forces within developed countries might change, and we have not begun to discuss the Middle East, OPEC, or Russia and China, for that matter.
Beside outright fraud and the cyber-crime wave, what other risks are out there?
We typically publish articles that have to do with the spread of outright fraud in our sector of the business world. For the past few years, cyber-criminals, however, have taken over the landscape with an all out assault on anything that can be “monetized”, as the saying goes. Personal identity theft via software robots is rampant. Account balances are at risk without warning. Ransom-ware is the latest threat, where your files are encrypted against your will, and you must pay a ransom for the key to unlock them. Basic fraud and Ponzi schemes are still alive and well, but, if you only pay attention to these fraud issues, you might miss the bigger picture. Risk wears many masks and never sleeps!
In a previous article, we outlined seven fundamental risk drivers for the currency trading industry for 2017. Here is a reprint of that list:
1) Industry revenues are contracting with uncertainty looming.
2) The Binary Option industry is under attack for shady business practices.
3) Current fraud trends will continue: Ponzi, Clones, and all manner of scams.
4) Cyber criminals will gain more momentum in all markets.
5) Regulatory broadsides will reshape industry dynamics.
6) Moves to convert forex to regulated exchanges will gain more support.
7) Industry consolidation will be commonplace.
These items were just a few of the direct threats within our industry’s purview, but there is always the external “Other” category that must be addressed, as well. From Brexit to Trump-onomics, the globe is reeling from an assortment of unfamiliar risk creators. In order to navigate these shark infested waters, one must become aware of the threats, understand how they could impact his or her individual situation, and then develop a plan to minimize the impacts accordingly. What are these other potential risk scenarios? Here is a brief list of what to look out for:
- President Trump – The Big Reveal?: President Trump will speak to a full Congress this evening, hopefully, to reveal the details about his plans to boost growth, cut taxes, and add jobs. His first budget proposal will be outlined, but, as one analyst noted, “Equities across the globe have been rallying strong during the past few weeks, with US indices breaking record levels day after day. The next couple of days will therefore prove a veritable landmine for investors.” Expectations are running high, but Trump could disappoint in a big way, one reason to remain cautious. The Dollar is trading down slightly, while safe havens gain: “Forex looks to be trading a little bit risk off today.” The Trump “reflation trade” could reverse, causing a rush to sell;
- Central Bank Policy Divergence: Despite political policy risk, the main theme of 2017 continues to be central bank policy divergence. Will the Fed raise rates while others are embarking on more QE? Fed minutes and those that are on the speaking trail sound hawkish that another 25 basis point hike in March is highly likely. The market is not buying in, if you accept that the futures market has only priced in a 33% probability at the moment;
- European Election Uncertainty: Populism reigns across the European continent, especially after the victory of related forces in the Brexit referendum. Dutch elections are scheduled for the 15th of March. France and Germany are next on the journey to who knows where. Per one analyst, “Despite a narrowing of French vs. German sovereign yields, a lack of volatility indicates that risk aversion has increased, as traders brace for a barrage of destabilizing events. European political uncertainty is not merely comprised of singular events, but rather rolling negative sentiment, which sees Europe paralysed by breakup fears.”
- Rising Political Tensions Elsewhere: When developed economies are tense, then political risk rises in the developing world. China, Russia, India, the Middle East, and elsewhere – Capital outflows suggest a problem is exacerbating, which can easily lead to political unrest, military actions, and massive refugee issues. Many of these markets are highly dependent upon oil revenues for funding government programs. Uncertainty in oil prices can immediately lead to repercussions that disrupt currency markets.
- Major Market Sell Off and Liquidity Crunch: Several doomsayers have been prophesizing a market meltdown for years, but this Bull keeps running right along, undeterred by overvaluations or extreme metrics. The latest boost from “Trump-phoria” has only emboldened the optimists, but storm clouds are building. The question often heard in hallways is, “When will this bubble burst?” Sophisticated modeling suggest an 18% probability of a 15% correction sometime in the next twelve months, but that pullback could occur at any moment without warning. Trading volumes today are dominated by algo-robots, which could issue similar “Sell” orders at the same instant and result in a dreaded liquidity crunch.
- Is a Recession Imminent?: There have been many headlines related to China’s soft landing, the decline in demand from Western countries, and low GDP growth dynamics in the developed world. Sophisticated economic models are not showing any early signs of a possible recession any time soon, but central bank policy has the global economy tied in a not. A return to realistic interest rates is inevitable, but gradual is the new normal. Can Trump add juice to the system or will he jerk it like a chain with dire consequences?
- When will Volatility Soar through the Roof?: Uncertainty, if not dissipated, will eventually erupt into volatility. If markets go crazy, all participants will have to deal with and accept systemic risk impacts, as they come. It will not be pretty. Safe havens will be in vogue, as will Gold and Treasury securities. It is best to have a contingency plan that has already been thought out and ready to go. Be prepared to avoid the pitfalls and take advantage of opportunities. For now, the clock is ticking.
How can a forex trader deal with increasing market uncertainty and risk?
Markets will always be unpredictable, but when they go rogue, i.e., go crazy with elevated volatility, a trader must adapt quickly or exit until there is better weather, so to speak. Forex traders need to be right, typically, 60% of the time in order to produce consistent “net” gains over time, including covering spread costs. When volatility hits, that win ratio suddenly escalates to 70 to 80%, unless changes are made in how you approach the market. Yes, you can lose a lot of money quickly, if you are not prepared.
Your broker also has to deal with increased risk, as well. Remember the “Swiss Franc Debacle” in early 2015? Brokers and traders lost billions in a flash. What are the best ways to handle market uncertainty? Here are a few trading suggestions:
- Rule #1 – Adjust your Risk/Reward Parameters: If you are caught flatfooted by the market, you may see your stop losses gobbled up in one fell swoop, well before you can adjust them and leave open the possibility for gain. Common sense says to be happy with smaller gains, i.e., a risk/reward ratio of 2:1 instead of 3:1. You may also want to set your stop losses to give more free rein to the market and cut back on your lot sizes, as well. Your goal is to adapt and rule out the possibility of a surprise.
- Rule #2 – Pull Back to Longer Timeframes: If you are a Scalper or love to trade with short timeframes, you and other traders might want to step back and look at the bigger picture, when volatility takes hold. Volatility has a way of amplifying noise in the system. Longer timeframes can smooth out this noise. Modify your risk and position management guidelines, too.
- Rule #3 – No One is Forcing You to Trade: If the kitchen gets too hot, then get out of the kitchen, unless you perform well in hot kitchens. Take a break. Patience is always rewarded in the forex market.
What about broker risk? Declining volumes, increased costs and competition, regulators on the rampage, industry consolidation, and market uncertainty to boot – Our forex brokers have to deal with a lot these days, and many of them are under financial stress. Are there ways to detect problems with your broker? Industry news is one source. If you notice that service is not what it used to be, related to execution times, customer service, or re-quotes, you may want to test a withdrawal request. If you run into problems, you may want to dig deeper and ask a number of pointed questions. If you are not satisfied with the answers given, then you may need a safer alternative.
There are two forms of risk – Systemic and Non-Systemic. The former impacts every market participant and cannot be hedged via diversification techniques. The latter encompasses the majority of risks detailed above. When uncertainty persists, veteran traders modify their positions to adapt to the level of risk perceived. If markets are unable to effectively measure risk premiums in their valuation processes, then they can become volatile, which can be both a good thing and a bad thing.
From the “bad” perspective, when forex markets begin to gyrate wildly, risk levels increase dramatically. If your broker is under financial stress, volatile markets will only amplify his problems. If you notice a degradation in service, you might want to consider a change. As for the volatile forex market, the decision to participate is yours and yours alone. If you can adapt and trade successfully, then so be it. If not, then take a breather and wait. There will always be another opportunity around the corner.