Things to Remember As the Market Dynamics Change

7 Mar 2022

A successful trader must be like a chameleon, willing to change with market conditions. Markets reflect the economic and geopolitical landscapes. The global pandemic changed many assumptions, forcing market participants to develop new skills to deal with the price carnage in early 2020. The impact of unprecedented central bank liquidity and government stimulus caused the need to pivot and adapt to new conditions.

• Plan first- Trade or invest later
  
• Risk-reward is critical
  
• Leverage is a function of price variance
  
• Stick to the game plan
  
• There are always other opportunities in volatile markets
  

In early 2022, Russia’s invasion of Ukraine has turned the world upside down. The US, Europe, and allies worldwide support Ukraine by providing aid and slapping Russia with sanctions. However, the meeting between the Russian leader and Chinese President Xi at the Beijing Winter Olympics was a watershed event and may have set the stage for the incursion. China and Russia entered into a long-term $117 billion agreement for Russia to supply energy and other commodities to the world’s most populous country with the second-leading economy. The deal could make US and European sanctions toothless or lessen the bite on Russia’s economy as President Putin moves to take the former Soviet satellite back under his umbrella.

With the US, NATO, and other allies on one side and China, Russia, North Korea, and Iran on the other, the risk of a confrontation with nuclear ramifications dramatically increased. The pandemic has given way to a geopolitical crisis, requiring another pivot by investors and traders to deal with the current environment.

Volatility is likely to be the norm instead of the exception for the foreseeable future. The increasing price variance is a nightmare for passive investors but creates many opportunities for nimble traders with their fingers on the pulse of markets.

Success in markets always requires discipline, and increased volatility only makes discipline more critical. In early March 2022, we must remember the key factors that increase the odds of success in markets.


Plan first- Trade or invest later

Organization and planning are critical in life, and trading and investing are no exception. In a highly volatile market, planning becomes even more essential.
We follow three rules for considering any risk position:

• Respect the market sentiment- The path of least resistance reflects market sentiment, making the trend your only friend in markets across all asset classes.
  
• Write down your ideas, planning, organizing, and memorializing your thoughts. Referring back to the original justification for a trade or investment will remind you of the thought process.
  
• Do not trade or invest for the sake of participating in any market. The risks in over-trading or investing without a plan increase with price volatility.
  

When considering entering any risk position, eliminate any emotional impulses by ignoring the news cycle and so-called “expert” advice. The price action is the most objective view of the market’s interpretation of the geopolitical and economic landscapes.


Risk-reward is critical
Any plan needs to outline the risk tolerance, which must be a function of profit targets. We follow three rules regarding risk versus reward:

• The risk-reward equation should be at least 1:1, meaning do not risk more than your expected profit level.
  
• Higher price variance should increase the expected reward level compared to the risk. Even the most successful traders call the market’s direction wrong more than right. A higher reward target versus risk increases the potential for success over time, allowing for small losses and higher profits.
  
• Never increase the risk level because an asset price moves contrary to expectations. Admitting you are wrong can be humbling, but it is a critical element for financial survival.
  

Risk-reward is the essential part of a plan that establishes the discipline necessary for success. Risk-reward levels should always reflect price variance, and higher price volatility requires more expansive risk-reward levels.


Leverage is a function of price variance

Leverage can be a blessing or a curse. Greed and fear are impulses that drive human behavior.

• Leverage levels should always reflect market volatility.
  
• In volatile markets, reduce leverage to protect capital.
  
• In static markets where volatility declines, increasing leverage is more appropriate.
  

When risk positions are in the money, greed drives us to feel we are not long or short enough. Fear makes us believe we are too long or short when they are out of the money. A plan and the appropriate leverage will help avoid listening to the little voice in our heads that incites the fear and greed impulses.


Stick to the game plan
Mike Tyson once said, “Everyone has a plan until they get punched in the mouth.” Markets are not forgiving when they move against our expectations. Sticking to a game plan prepares you for the sock in the kisser.

• The risk level should be set in stone at the beginning of any trade or investment.
  
• It is acceptable to increase reward horizons when prices move in our favor.
  
• A risk position is always long or short at the current price, not the execution price.
  
• Assess risk at each price level and adjust levels accordingly.
  
• Adjust risk levels using trailing stops when an asset’s price moves in the desired direction.
  

Never allow a profitable position to become a loser by expanding the original risk level. Protect capital by protecting profits and have the fortitude to take small losses by sticking to the original game plan. When prices move contrary to expectations, admit to yourself you were wrong. When prices move in your favor, do not allow greed to creep into the plan.


There are always other opportunities in volatile markets
Most traders or investors will miss many trades and investment opportunities. Do not despair! In volatile markets, there is always another opportunity right around the corner.

Markets reflect the geopolitical and economic landscapes. The dynamics have dramatically changed with Russia’s invasion of Ukraine. Elevated volatility in markets across all asset classes will be the norm, not the exception.

When approaching markets, do the work and write down a plan. Make sure it has a logical risk-reward balance that reflects price variance before executing a buy or sell order. Follow the rules by sticking to your plan. Eliminate fear and greed emotions by establishing comfortable risk-reward levels.

A successful approach to trading and investing requires a portfolio approach. No one trade or investment should determine overall results. There are no guarantees in any markets, but following rules, sticking to a plan, and eliminating emotions will improve your chances of long-term success.

Be careful in markets as the dynamics have changed.

--
Trading advice given in this communication, if any, is based on information taken from trades and statistical services and other sources that we believe are reliable. The author does not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects the author’s good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice the author provides will result in profitable trades. There is risk of loss in all futures and options trading. Any investment involves substantial risks, including, but not limited to, pricing volatility, inadequate liquidity, and the potential complete loss of principal. This article does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.