Three ways to manage market volatility

Recent world events have shown the importance of risk management for spread betters. You don't want to get caught in a position that could trigger huge losses when markets are this volatile. So how can you reduce your losses when formerly calm markets turn jumpy? Here are three techniques.

By Tim Bennett

published 22 March 2011

in Features

Last week's dramatic stock market and currency swings, triggered by the Japanese earthquake and civil war in the Middle East, revealed the importance of risk management as a spread better. In highly volatile markets you don't want to get caught running a position that could trigger huge losses. So how can you reduce your losses when formerly calm markets turn jumpy? Here are three techniques.

Keep bets small

Sure, you'll read about the time George Soros shorted the pound in the early 1990s and cleaned up. Or perhaps tomorrow you'll hear of some hedge fund that made a fortune betting big on the yen last week. But these are the exceptions, not the norm. Most spread betters make steady, regular profits they do not hang around waiting for that once-in-a-lifetime payoff. So, keep your bet sizes sensible and understand the risk you are taking. For example, a £10 per point bet on Tesco where a point is a 1p movement in the share price, offers the same exposure and profit potential (roughly) as someone who owns 1,000 Tesco shares. If you didn't know that, do some more homework before betting!

Use stop losses

Currency markets in particular can be highly volatile. So always use stop losses - and ideally guaranteed stops that get you out at a pre-set rate regardless of market conditions. Anyone who was short the yen when it rocketed briefly last week would have been very grateful for one of these!

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Don't panic

The classic response of a private investor to a short-term event is to throw the baby out with the bathwater. For example when stock markets tanked last week, many investors will have lost their nerve and sold up only to watch markets recover this week. If you limit bet sizes and use stop losses you should be able to ride out any short-term drop. And then look for the chance to get back in again with a long bet.

In other words, if you get caught out by a large downswing in stock prices, keep calm and seek opportunities to make back your losses. If a single bad day is going to stun you into complete inactivity then try something other than spread betting!

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.