How to Deal With Black Swan Event Losses

In less than 24 hours a potential market-mover is set to take the forex scene for a ride. Yep, I’m talking about the EU referendum! In case you missed it, our British friends are about to decide if they want to either stay or leave the European Union (EU). Check out Forex Gump’s neat Brexit primer if you want to know more about it.Fotolia_70389227_Subscription_Monthly_M-1

What you should remember about the event is that both scenarios come with some degree of uncertainty not only to the U.K. but also to the global economies. And, due to the unprecedented nature of the referendum, either decision could lead to wide spikes and swings across all financial assets.

This reminds me of the time when the Swiss National Bank (SNB) surprised the markets with the decision to stop defending EUR/CHF’s 1.2000 floor.

The move went down in history as a Black Swan event, an unpredictable, unforeseen event that had significant impact across financial markets. The SNB’s decision cost many market players a lot of money, and even forced some brokers and other financial institutions to close shop for lack of capital.

Average Joe retail traders also got caught in the SNB’s storm. We’ve heard stories of trades that got triggered hundreds of pips away from their orders, brokers who are now incommunicado, and investors who have lost everything but the shirt on their backs.

So how can you protect yourself from black swan event losses? Or, failing that, how can you pick yourself up from your trading losses? Here are three things you can do:

1. Manage Your Risk

This is a no-brainer. The first defense against unpredictable, unforeseen events is limiting your potential losses. Put stop losses in every trade and always be aware of your account exposure. Make sure you don’t put all your eggs in one basket. If anything, trade many small, uncorrelated positions and get bigger only if the trade goes your way and you expect it to keep going. Most importantly, NEVER risk money that you can’t afford to lose.

2. Be Informed

Forex Ninja has a list of the measures implemented by some major brokers ahead of the Brexit vote. Talk to your broker to clear up any questions you have. If you can’t contact your broker, try interacting with trading communities in case someone has more information.

If you’re one of the unfortunate souls who have sustained significant losses and have brokers who suddenly aren’t available, then the first best step is to talk to regulatory agencies to know your rights as a client.

Use the SNB event to compare how forex brokers have reacted to the situation and consider using more than one of them. Then, review the trading agreement with your broker before you place your next trades. Just because you can’t predict the markets doesn’t mean that you can’t predict what could happen to your hard-earned profits in the event of another black swan.

3. Build Your Account Back Up

Once you’ve accepted your losses and done your homework for future trades, all that’s left to do is to pick up the pieces and build your account back up. Trade demo accounts if you can’t afford another live account yet. That way you can still fine-tune your processes and keep your trading skills sharp.

By its definition black swan events are unexpected and extremely difficult to predict. It’s possible that we could see huge gaps, wild swings, and increased volatility during and after the Brexit vote. Or we could see no movement at all. Either way, the best way to protect your account is to be prepared for as many scenarios as you can and to always manage your risk.

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  • biebel

    Personally I would not qualify the Brexit referendum as a Black swan event. It was scheduled well in advance, although the outcome is uncertain. In my book black swans like to come as a thief in the night, unannounced.

    • Dr. Pipslow

      Good point, biebel.

      I’ve tagged the EU referendum as a potential black swan since it’s a historical event and there are few events to compare it with. Luckily for us, the post-referendum action wasn’t as crazy as everyone feared. I generally recommend staying in the sidelines during these kinds of events though.

  • David Kelly

    Due to Brokers respecting “take profit” levels and not “stop loss” levels (gaps your position right past them and automatically stops you out wherever it gaps to) it seems to me any position with a stop loss on when an extreme spike in pricing occurs only guarantees a big loss and actually does the OPPOSITE of protecting you since most extreme gaps will eventually retrace significantly. If a price gaps past my stop loss I would rather wait it out rather then guarantee a big loss and am very offended that if that gap happens to blow past your take profit they only give you the profit to there and NOT to where it gaps to. I am considering using alerts rather than hard targets on all of my trades to protect myself from these events.

    • Dr. Pipslow

      Thanks for your two cents, David!

      Unfortunately, due to the nature of “black swan” events, we can’t really cherry pick the trades that we put stop losses to.

      Stop losses, though not infallible, are still our best bets to protect us from account-killing losses. Also, gaps are tricky since we don’t know exactly when they’ll close. A trader can blow his/her account before a gap closes. Using alerts is a good idea though, especially if you have easy access to your platform.