Trading in a Low Volatility Environment

A couple of days ago I stumbled upon an article written by Forex Ninja, which tells us why forex traders should get used to seeing low volume and volatility. While some traders like to sit on the sidelines and wait for the golden times of high volatility, others take this as a challenge to expand their trading skills. After all, the shift in market environment is just another thing that consistently profitable, career traders have to adapt to.

If you want to try your hand at trading in low volatile market environment, here are three tips that might help you:

Focus on Range Trading

Perhaps one of the first things that you should learn when trading in a low volatility environment is to trade in lower time frames. Put trend-catching systems on the shelves for now and explore trading strategies that work well in a ranging environment.

If you don’t have strategies for a ranging market, then feel free to browse through the past winners of the Best Forex Trading System of the Month contest. Forex Ninja runs has compiled the best systems (chosen by BabyPips.com readers, of course) in a neat little forum post.

Now, if you don’t want to veer away from your current system, you can also slowly add in indicators that do well in a ranging environment. You can try out indicators like Stochastic, the RSI, and the ParSar. For more information on how to use them, just head on over to the Leading and Lagging Indicators lesson in the School of Pipsology.

Trade Cross Currency and/or Exotic Pairs

Stepping away from the major pairs (and some of the popular crosses) can open up a new world of opportunities. These seldom watched currency cross pairs and exotic pairs naturally have low liquidity. This means that volatility may be higher, especially on big news events (e.g., The 20-day average true range of GBP/NZD, for instance, is 121 pips–notably much bigger than GBP/USD’s 64 pips and NZD/USD‘s 57 pips!).

Also, trends can be found in these pairs as they tend to be influenced more by a country’s underlying fundamental outlook rather than “risk-on/risk-on” sentiment and daily market noise.

Now there is a caveat when trading these pairs. First, because of the naturally low liquidity, the spreads may be higher and the value-per-pip move will be different than what you normally see with the more popular pairs. If you’re not aware of that when you set your position sizes, you could be in for a rude awakening as soon as that trade opens.

Second, during violent shifts in market sentiment, the odds of your limit order getting filled at your desired entry price is greatly reduced (i.e., a higher potential for slippage). But as with any trade, a good risk plan and a careful eye on the market will limit any damage these risks have on your account.

Cyclopip, our resident cross-currency expert, trades crosses and exotic currencies very well. You can check out his blog for ideas on how to take advantage of these types of currencies in a low volatility environment.

Manage your Expectations

Just like how a golfer adapts his/her putting strategy to the wind direction and steepness of a green, your behaviors and expectations must also adapt to low volatility trading.

Adjusting your expectations is a good place to start. Accept that you won’t be seeing multi-hundred pip moves as often as you want to; you can forget about adding to your existing positions and start thinking about smaller targets for a majority of your trading sessions.

Besides, smaller pip targets doesn’t necessarily mean less profits. You can always make up for the lack of volatility by trading bigger positions and placing tighter stop losses. But be prepared for the psychological impact of trading larger positions!

Last but not the least, you should prepare for breakouts. With the euro zone coming up with solutions to solve its problems and the U.S. officials working on the fiscal cliff, a big, market-moving announcement is always lurking around the corner.

In a low liquidity environment, this will most likely induce spikes in buying and selling. So, be prepared by having plans in place to limit risk during surprise events and to take advantage of them if they happen.

It’s almost the end of the year, folks! Don’t let your 2012 trading profits shrink by failing to adapt now. Remember, adaptability is the key to surviving and thriving in the forex industry!