Trading : how to deal with crashes (small or big)

Question

i'm currently learning how to trade both manually and with EAs.

I have questions : i'd like to know how to deal in the probability of a price crash like in 1987 (and many others):

1. Is using a right amount of Stop-Loss enough to counter the money loss? (theorically, yes?)

2. Is it possible to simply wait for the price to go up again from a very low price (i'm aware it might not come back to the original price, but is it enough to prevent a huge loss of the capital especially when using leverage?)

3. If we wait, will the broker let enough time for the price to come up again (unlike in the recent Alpari misfortune that closed because of a Swiss currency high volatility)

4. Is there any other tip i should know to deal with that?

i've looked everywhere on the net but i couldn't find a good answer, so...

thanks a lot guys!

Jeff Le Bas

Answer 1

1. yes... but it has to be "right" as it could stop you out of the market on volatility alone on occasions if your stop is too close to the market price. You can use historical volatility to estimate this.
2. As long as you are not trading on margin, or on instruments that might reach maturity before it regains its previous strength, then this is a valid course (although you need to learn when to just take the loss and move on). If you are trading in a margin account (i.e. using leverage) then a margin call will occur and you will have to post more margin which incurs further costs (if only as opportunity cost).
3. as long as you can cover margins, costs etc a viable broker will give you as much time as you like to hold an instrument but again be careful of maturity of that instrument. HOWEVER there is the issue of counterparty risk; can your counterparty (i.e. broker) be relied on to be able to fulfil its contracts with you? You mention Alpari going out of business and other brokerages have gone bankrupt in the last few years, in general as a brokerage customer you are very high up the liquidator's list of people to repay but it is still possible that there will not be enough equity left in the firm to repay (all) of the money contractually owed to you. In that case you will lose even more money when you're winning than when you're losing.
4. (i) You seem very interested in not losing too much money but don't mention keeping any money that you have made - take profit orders will allow you to crystalize any profits if you expect prices to peak and then fall back (they do this as a rule and not an exception). (ii) don't forget that you can hedge your position by taking an opposite "bet"; you mostly mention FX in your example where the obvious short position is to take the opposite position in a correlated currency but you can also use put and call options to similar effect. If I am holding 1m USD as ZAR at 11.581 (ok that's the price right this second...) I can buy a put option to sell some of that quantity (I can't calculate the ideal hedge quantity right now) at that price which means that I have paid to lock that price in. I strongly recommend that you learn all about delta hedging if not about other types as the concepts are very useful for managing risk.

caveat: remember that complex derivatives can be very bad for your wealth (even if you FULLY understand them).

Answer 2

You can buy out of the money put options that could minimize your losses (or even make you money) in the event of a huge crash.

Put options are good in that you dont have to worry about not getting filled, or not knowing what price you might get filled with a stop-loss order, however, put options cost money and their value decays over time. It's just like buying insurance, you always have to pay up for it.