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How to protect yourself during the year end in trading?

As forex traders, and especially day traders, one is often inclined to find trading opportunities regardless of the time of the day. However, as anyone who has traded for a while would know, liquidity is off the biggest concern.

When there are not enough market participants, price action can behave erratically. This is especially true if you are trading with a forex broker that offers variable spreads. In such instances, the spreads are not fixed by the forex broker but keep changing depending on the liquidity offered by the forex broker.

During such periods, regardless of how robust your trading system may be or how good your trading analysis might be, there is a very good chance that the erratic price action movement can lead to unforeseen losses.

When there is a lack of liquidity in the market, the spreads tend to widen quite a bit. Therefore, this would result in your stop loss or you take profit levels being hit prematurely. In turn, this would greatly reduce the profits that you would be making in an otherwise liquid market.

While it is a known fact that liquidity during the late US trading session and the early Asian trading session is quite low, the liquidity also changes during the different times of the year. As we reach the end of the year, most of the trading activity slows down.

However, this is not the case when it comes to the retail forex traders. You will often see that retail traders continue to trade even during the holiday periods. This is a time when trading volumes drop significantly at least from an institutional perspective. Therefore, during such periods, it is very much possible that prices can move erratically by just a few couple of big orders. Traders need to bear the risks in mind when trading during such periods.

The final weeks of December often see such kind of a movement which leads into the first few days of the new year. This is due to the fact that many institutional traders such as financial institutions and big banks are closed for business. This apparent lack in the liquidity, can attract some buyers and sellers who would like to manipulate the market.

This phenomenon is found not just in the forex markets but also in the equity and futures markets as well. And the situation gets even worse if you look to the penny stocks which are already in liquid and the lack of market participants during the year end can lead to some unscrupulous elements that can pump and dump the prices.

What to watch out for during illiquid markets?

in order to protect yourself against the erratic price movements, the obvious question that comes to mind is how to first recognize that the markets are illiquid. The easiest way to understand this is to simply look at the price charts themselves. During the illiquid markets, you will see prices trading in a very tight range.

You will also notice that the spreads tend to be unreasonably higher comparing to the average spread during the regular trading months. When the prices are trading in a tight range comma any reasonable trader would know that it could soon result in a strong breakout.

While breakout trading is a popular way to capture huge profits in a short period of time, the resulting widening spreads can also have a big impact on your bottom lines.

GBPUSD Yearend

GBPUSD price action during the year end

The above chart, you can see the GBPUSD currency pair During the Christmas weekend. As pointed out on the charts, this results in gaps that can form in the market. You can also notice that these gaps often occur during the opening sessions of the day. Furthermore, if you look at the charts closely you will see that price action moves in a very consolidated way. Following this brief period of consolidation there is also a strong breakout in the markets.

Most of the times, the strong breakouts are what attracts the gullible retail trader into taking up the positions. But as mentioned, this can be a risky proposition which can lead to losses in real time. The best way to protect yourself against such movements during the end of the year is to simply take a break from the markets and shut down.

You could instead look at reviewing potential positions in the market in the future, or you could also look at reviewing your past trades. Overall, the trading periods starting from the Christmas weekend to the first few days in January are often lacking in liquidity and can therefore lead to big price movements.

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