Whipsaws And How To Avoid Them

"Whipsaw" is a word that strikes fear into the heart of every trader. The smaller your account the more afraid of being whipsawed you are likely to be. Whipsawing is when the market fills your entry order and your stop loss exit order in the same session, effectively stopping you out for a loss. The summer months are especially bad for whipsaw trades.

Since many of the commodity markets are crop markets they are extremely sensitive to any changes in market or crop conditions, and will react quickly to a change in either. This quick "about face" has the potential to whipsaw you out of a seemingly good trade.

One other reason that whipsaw trades are more likely to occur during the summer months is that many traders are on summer vacation, this is especially true the last few weeks of August as families try to squeeze in a couple of weeks away before the children have to go back to school. The absence of some of these traders leads to a slightly thinner marketplace, which in turn can lead to larger daily ranges and the resulting whipsaw trade.

So what can be done? Is there anything the small trader can do to avoid getting whipsawed? While there is no foolproof way to avoid getting whipsawed there are a couple of things you can do to make it less likely. The most important thing you can do as a small trader is to use only the strongest support and resistance levels to base your trades on. Using the stronger resistance will normally keep you on the right side of the market and "make the market come to you" before entering the trade.

If the risk vs. reward ratio allows it, I normally like to see the market break a secondary support or resistance level before entering the trade. Sometimes this means giving up some potential profit, but in return you will usually get into a trending market instead of one that is just chopping about. The second benefit of waiting for the market to breach a secondary resistance level is that you can use the stronger support or resistance area to cover your trade, which should enable you to keep risk to a reasonably small amount.

It is also important that you continue to try and trade with the trend as much as possible, especially at this time of the year. Do your best to avoid countertrend trades unless you have a very good reason for taking one, and if you do take a countertrend trade keep your exit stop close and use a profit taking target to maximize your potential profit. Bear in mind that because the markets tend to be choppier at this time of the year, you should avoid placing too much emphasis on any single daily range - unless it is a large range of course.

Because of the added choppiness it is more important than ever to be patient with the markets. Be prepared to see the markets look bullish one day and bearish the next. Don't get caught up in trading the daily changes however, keep your eye on the bigger picture. Step back and take an overall view of your charts in order to keep your perspective if you find yourself concentrating too much on the last few bars of the chart. If necessary consult a weekly chart which will normally show the predominant market trend more clearly than the daily.

Lastly realize that whipsaws are a part of trading. Regardless of how well you search out your support and resistance lines and monitor your opening ranges, whipsaws can still occur. Fortunately for us support and resistance technicians, we can usually keep the losses small enough that they do not adversely affect our accounts; although our egos can be a different story.

As unpleasant as whipsaws are, try not to let them affect you too much emotionally. Avoid the desire of trying to "get even" with the market. This rarely works and will usually only make matters worse, likely resulting in yet more whipsaw trades. After all, we are dealing with an uncertain future. Sometimes the market will behave as it is supposed to, and other times it will not. It is important that at those times when the market is not behaving as anticipated, you exit the trade with as little damage to your account as possible.

Take solace in managing your account well, even if it is a losing trade. This is what differentiates traders from fortune tellers. Whipsaw season will pass soon; just make sure you have enough of an account left that you can still trade when it is over. Sometimes the best course of action is just to wait the market out for a few weeks until things begin to look a little more settled. Remember, no one says you "have to" trade at this time of the year.

No Investment Is Safe! The Types Of Investment Risk

If you've been researching the basics of investing, you`ve most likely read a little bit about the varying degrees of risk in different investments. I'd like to look more closely at risk and find out what it means how we can deal with it. Risk is the possibility of loss to your investment. If there is no guarantee that you will receive your maximum possible return, then there is risk of some kind. All investments involve risk.

The most basic kind of risk involves a loss of principal (the original amount of money that you invested). If you buy a stock or mutual fund or invest in real estate, there is no guarantee that you will get all of your principal back. You can greatly reduce or eliminate the risk to your principal by keeping your money in a bank savings account, purchasing a fixed term deposit (agreeing to deposit your money for a specified amount of time), or buying investment grade bonds. But even when you guarantee your principal, there are still other kinds of risk.

Another kind of risk is inflation risk, the risk that your money will hold less value in the future than it does now. Keeping your money in a bank savings account, and to a lesser extent a fixed term deposit, exposes you to inflation risk because your returns will probably be lower than the rate of inflation. This is why banks are terrible places to leave large amounts of money for more than a short time.

Another kind of risk is opportunity risk. This occurs when you lock up your money in an illiquid investment, like a fixed term deposit with very modest returns, and miss an opportunity to invest in something with a chance of much higher returns. When I first began learning to invest, I was in a hurry to get started and put around $5000 into a fixed term deposit. I didn't know much about investing, so I plopped my savings into a guaranteed investment. About 1 day later, there was a drastic drop in the stock markets, which would have been a golden opportunity for me to buy stocks while prices were low. But I couldn't buy stocks, because I had committed that $5000 to a 1 year fixed term deposit with no option of early redemption. I could have made some real gains on the stock market, but I was stuck with a modest 5 percent interest rate. I had avoided risk to my principal, but I was bitten by opportunity risk. You can avoid opportunity risk by keep your money in liquid investments like stocks and mutual funds with no minimum time commitments.

Opportunity risk is similar to marketability risk, which is the chance that there will be no buyer available when you wish to sell your investment. This is important especially with real estate. Selling property can take a long time. You need to hire a realtor, advertise, have open houses, etc. If you need that money immediately, you will likely be out of luck. Your money is tied up for the time being. Real estate is not a good investment to make if you may need to liquidate it anytime soon, or at short notice.

Another kind of risk, and one of the most major, is concentration risk. This occurs when you have too much of your money concentrated in one area, for example all in one particular stock or all in one industry. Have you heard of Enron? Well, anybody who had their investments concentrated in Enron ended up getting the shaft. When the dot com bubble burst several years back, a lot of people who had their money concentrated in new internet businesses lost everything. The lesson to learn here is to diversify your investments. Diversification, as we've mentioned before, means holding a variety of different investments across a variety of sectors so that if one of your investments flops, you are losing only a small portion of your money rather than a large portion of it or, God forbid, all of it. It's of central importance to build a diversified portfolio to reduce your concentration risk.

Another kind of risk is interest rate risk, which is the possibility that the relative value of your investment will decrease due to changes in interest rates. This is mainly relevant for fixed income investments like bonds. If you buy a bond with a fixed 5% interest rate, but then market interest rates increase, you may be stuck with that bond at a 5% interest rate even though bonds with higher interest rates are now being issued. The dollar value of your investment upon maturity doesn`t change, but the relative value has changed, since there are now other people out there earning more interest than you. This will decrease demand for your bond, so if you decide to sell it it will fetch you a lower price than the newer bonds with higher interest rates. Interest rates have a profound effect on various aspects of investment, but this is the most basic kind of interest rate risk to understand for now.

Another kind of risk is currency exchange risk. Currency exchange rates are constantly fluctuating and can change the value of your investments. If the base currency of your investment is different than the currency you are purchasing with, then the value of your investment will fluctuate depending on the currency exchange rates. For example, if you buy a China growth mutual fund whose base currency is the Chinese Yuan, and you buy it in US dollars, then any increase in the Yuan will work in your favor when you sell the investment, and any decrease in the Yuan will work against you when you sell the investment. This risk can not be eliminated and it is best to have a balance of hard currencies. Hard currencies are basically trusted currencies of stable countries with consistent fiscal policies.

Those are some of the major types of risk you need to be aware of. Once you understand these kinds of risks, you can determine your own risk profile and decide how much risk you are prepared to take on.