What is Volatility Protection and How Can it Help You with Your Trading Strategy?

While the current market environment is relatively benign from a volatility perspective across the more mature asset classes, with the volatility index VIX at historical lows, volatility will remain one of the factors for investors and traders to consider. There are many investors looking for products that smooth out volatility across investment holdings, and there are those who look for the volatility trade, particularly day traders looking to take intraday scalps.

It ultimately boils down to an investor’s risk profile and, the more risk averse an investor, the greater the desire for protection against short-term losses that could be material once volatility wakes up from its deep sleep, or for those looking to become a part of today’s cryptomania.

Those looking to trade cryptocurrencies, for example, don’t have the benefits of the VIX, with the cryptomarket known to be particularly volatile, making protection all the more relevant.

Some investors may have forgotten the days when the more mature asset classes moved in similar trends to what we’ve seen in recent weeks, but on a more prolonged basis that was once called the norm. Directional trades are certainly rewarding until they change direction, and when leveraged, the gains could evaporate far more quickly than they were made.

What is Volatility Protection Strategy?

While a diversified investment portfolio may provide some degree of protection against volatility, there are other tools and products available to investors and traders looking to avoid the rollercoaster ride that many have and will experience time and again throughout an investment cycle.

The downside to volatility protection is lower returns, whether this is through a diversified portfolio or by incorporating alternative strategies, with even volatility protection strategies capable of taking a tumble in periods of extreme market stress. The upside, however, is the fact that the declines would be significantly less severe compared to an unprotected investment portfolio exposed to any asset classes that is directionally focussed.

For many, the upside to volatility protection strategies is certainly not an alluring one, but once an investor has been bitten by market volatility, pretty much anyone who invested in the equity at the time of the global financial crisis or in the British Pound at the time of the EU Referendum or even the cryptomarkets since the beginning of the year, the allure for volatility protection certainly grows, particularly for those looking to protect their capital or even their nest egg.

Volatility Protection Tools

A number of tools are available for protection against volatility, with volatility tools embedded within trading order options, while some trading platforms also provide trade settings to provide further support to those looking to soften the adverse effects of volatility on one’s positions.

Tool features include:

• Limitation of maximum price slippage on market and stop orders: Enables entering the market with limited risk, while removing any limitations to upward gains. Traders are able to predefine maximum acceptable slippage from 1 to 1,000 points per account. When a stop order is triggered or a market order is placed, a limit order is placed instead at the price that is less favorable by a predefined amount of points. Negative slippage is therefore protected, while positive slippage would result in an unlimited limit order.
• Limit or fully avoid losses on pending orders falling into price gaps: Protects investors from instant losses that can stem from a pending order with a predefined stop-loss level, both of which are triggered on the same tick. Pending orders would automatically be canceled if they have stop-losses or take-profits triggered on the same price tick.
• Partial execution of limit orders: Get filled on larger orders by enabling the partial fills and allowing to fill your orders part by part. This is particularly useful in less liquid markets.
• Avoid order activation due to spread widening, when there is no actual movement in the market.
• Market execution of limit orders: Used to avoid situations where a limit order is reached on a price spike and not executed due to the lack of liquidity beyond the level.
• Activation of stop orders using reversed quotes: Used to avoid the activation of stop orders due to widened spreads during economic news releases and other volatile market conditions, which may not result in an actual change of the price level.
• Cancellation of pending orders on price gaps: Used to minimize market risk.

The volatility protection tools mentioned above are available with Admiral Markets, which provides a platform for trading cryptocurrencies, Forex currency pairs, commodities, indices, shares, and bonds through CFDs.

Few traders would argue with the need for proper volatility protection when trading cryptocurrency CFDs or any other volatile instrument, with daily movements of up to 10-20%, while the more mature asset classes move within tighter ranges outside of extreme market stress conditions.

Cryptocurrency CFDs offered by Admiral Markets include the following pairings: BTCUSD; BCHUSD; ETHUSD, LTCUSD, XRPUSD, DSHUSD; XMRUSD, and ZECUSD

The Benefits of Volatility Protection

The use of volatility protection, whether through a blended portfolio to rein in volatility or through the use of volatility protection tools, is crucial when investing in more volatile asset classes or when making the use of leverage to increase potential income from intraday or longer-term positions.

Leveraged trading can ultimately lead to the loss of capital invested and possibly more should a trader look to hold on to positions and post margin in the event of the market going the wrong way. Appropriate volatility management certainly avoids scenarios in which traders may hope that a particular position recovers in order to minimize losses.

Capital preservation must be the utmost priority for any investor or trader. After all, without the initial capital, there are no trades and, with no traders, there is no return to make on your investment.