Trading in Thin Markets
Joe Perry December 26, 2019 1:28 PM
ALWAYS ask yourself first “How much can I lose?”
Wow! What a move yesterday evening (in the US) on Christmas Day in the US Dollar Index! The DXY inexplicitly fell over 100 pips yesterday and bounced back immediately. Stocks are at all-time highs, again. NASDAQ crossed 9,000 for the first time EVER!!! Gold is up 10 dollars. (It’s considered an unusual correlation to have stocks and gold moving in the same direction). And why is this happening on Christmas Day and Boxing Day (a holiday in many countries outside the US)? I haven’t seen any big news headlines to move the markets.
US Dollar Index, 5-minute
Source: Tradingview, FOREX.com
As we have discussed last week, sometimes large pension funds, mutual funds, and hedge funds need to move money for year end. Whether its to close positions or “window dressing”, the closer we get to December 31st, the less liquidity there will be. This adds potential for larger swings as there are less participants in the market.
How can we participate in these moves without getting run over if moves such as these continue into year end? Smaller size and wider stops!
As a hypothetical example, let’s say you usually trade a standard lot of $100,000 in EUR/USD. Your risk/reward is 1:3. If you risk 30 pips and you are looking to make 90 pips (1:3), your risk is $300. If the market spikes 50 pips against you and comes right back, your stop would be taken out.
Now, let’s say you still have a risk/reward of 1:3 and you trade a mini lot of $10,000 in EUR/USD. You can move your stop out wider, say 75 pips, as your maximum loss would only be $75. You can initially look to make 225 pips (1:3). If there is a 50-pip spike against you, your stop will not be taken out. And as the trade moves in your favor (or if the trade moves in your favor), you can adjust your target and stop as needed.
The point is, although you will make less if the market reaches your target, you would also lose less if the market goes against you! This is important to remember is thin, illiquid markets. Regardless of market conditions, ALWAYS ask yourself first “How much can I lose?” before you ask yourself “How much can I make?”!
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