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Risk Management and Controlling High Volatility

The financial market is highly volatile as we have been facing war in the Middle East, which has disrupted inflation and growth in 2026, according to the IMF.

However, many investors and traders may ignore the volatility as it could make a quick profit for them, and they are willing to risk more, which often leads to losses in the end. Risk management can help you protect your capital against potential losses in the volatile market.

In this lesson, we will guide you on how traders can optimize trading size, where to place a stop-loss, how a trailing stop order works, how to handle high-volatility markets, and how to protect your portfolio during unexpected events.

How to Determine Position Sizing?

Position sizing determines how much capital you can allocate to each trade. It is considered based on your account size, risk tolerance, and stop-loss placement. This helps traders avoid unexpected events and market volatility.

Here’s the basic formula:

Position Size = (Account Risk $) / (Trade Risk per Unit)

Let's see an example from the case study: position sizing in gold trading

If you have a $10,000 trading account and you're following a risk of only 1-2% per trade. This means you will risk around $200 on this trade.

You buy gold at $ 2,000 per ounce and set a stop-loss at $1,950, which means you risk about $50 per unit.

The calculation will be $200/$50 = 4 units or ounces. Then it means you should buy 4 ounces of gold, and not more than 4 units.

How to Use Stop Loss and Trailing Stop Orders?

A stop-loss acts as your safety belt, helping you limit potential losses. While trailing stops help you adjust selling trigger points. The combination of both provides a balance of gains and losses in your trading.

Stop-Loss

A stop-loss is the easiest way to manage risk on a trade. This helps traders lock in profits and prevents them from engaging in emotional trading. Traders often use it to define the point at which the trading idea is no longer valid or the area where losses begin to hurt.

Source: Gold Futures, 15M; TradingView

Example: Based on the Gold Futures price chart at 15M, the price has swept through liquidity on the left-hand side at 4,080.2, then back to retest at 4,055.4, but immediately reverses back down. The price has triggered the stop-loss at 4,034.8, which is an acceptable loss rather than a larger one.

Trailing Stop Orders

An order that helps you lock in gains while being able to adjust your stop-loss favorably. When the price reverses and touches your stop-loss, the order will automatically close. This type of stop-loss is often used after the market order, which is more flexible in defining your exit.

Example:

Source: WTI Oil Futures, 30M; TradingView

According to Oil at 30M, we're taking a short trade from 2.00970 with a profit target of 1.96737. Our trailing stop-loss is placed above the previous swing high

Source: WTI Oil Futures, 30M; TradingView

Price has broken the structure, as shown on the chart. We moved the trailing stop-loss from the previous swing high to the recent swing lower highs, as it confirms the break of the structure.

Source: WTI Oil Futures, 30M; TradingView

Traders can keep moving following the downward price movement. Now, we have moved the trailing stop-loss to the recent swing high.

The price starts to reverse, and the order will move to closed automatically when it touches the stop-loss. However, we have already protected the profits and the unacceptable loss.

How to Manage a Portfolio during a High-Volatility Market?

Portfolio value changes over the given period, influenced by factors such as the global economy, financial market conditions, and political conditions. Volatility refers to price fluctuations over time and may impact a long-term investment plan.

Based on the case study of how to balance a portfolio in a high-volatility market using the DCC-GARCH t-Copula model (Patton, 2006), which was applied to 14 assets, including stocks, commodities, forex, and indices.

This study shows that when volatility increases, risk increases as follows. Therefore, investors and traders need to manage their portfolio dynamically rather than statically, as suggested below:

1. Portfolio Diversification

A wide range of assets helps you manage your portfolio and balance it if one type of asset performs poorly. Spreading a portfolio across assets can help balance returns when unexpected events occur, such as the global pandemic that began in 2020.

An example in Q1 2013 during the financial crisis from Bullion By Post has explained:

• If you invest in the S&P 500 at $80,000 and Gold at $20,000, you will receive a profit return of $147,996.

• If you invest in the S&P 500 at $95,000 and Gold at $50,000, you will receive a profit return of $115,119.

• If you invest only $100,000 in the S&P 500, you may gain $104,160 or lose $42,580.

This shows that adding gold to your investment portfolio will help you balance profitable returns and risk more effectively.

2. Choose High-Quality Assets

It’s important to have quality assets that are stable across different global economic environments, have consistent cash flow, and are low-risk. The high-quality assets help stabilize your portfolio during volatile markets and benefit investors in the long term.

For example, UK Treasury Bonds or US Treasury Bonds are considered stable, low-risk, and backed by governments that can be trusted for cash flow.

3. Regularly Review Your Portfolio

Even if you're investing for the long term or doing DCA, you still need to review your portfolio to rebalance it. This helps you see whether the assets generally perform well or underperform. However, this doesn't mean to sell the bonds or stocks because of the bad performance.

For example, you start with $100,000, with 60% ($60,000) in stocks and 40% ($40,000) in bonds. This means you can only accept risk by allocating 60% to stocks and 40% to bonds. If one of these increases, you need to rebalance it, as it increases risk.

After a year, the stocks grow to $80,000 while the bonds remain at $40,000. The portfolio is now valued at $120,000.

• The stock is now showing 66.7% from $80,000 our of  $120,000.

• The bond has increased by 33.3% from $40,000 at the beginning to $120,000.

To rebalance the portfolio back to 60/40 from the beginning, we sell $ 8,000 of stocks and bonds, since the stock value is not $72,000 and the bond value is now $48,000.

How to Handle Price Gaps and Unexpected Events?

A price gap is an area on the chart where the price moves too quickly without transactions between the levels. This is often caused by unexpected events such as geopolitical shocks or pandemics.

The price often forms at the opening market, intraday, or during sharp momentum movements.  This price movement signals high volatility, wide spreads, and often involves liquidity risks.

1. Plan ahead by monitoring economic calendars such as Forex Factory

2. Consider whether to trade based on news, such as corporate earnings, economic data, and Fed announcements.

3. Setting up your stop-loss and managing your size position (risk to reward).

Key Takeaways

• Risk management is one of the most important parts of trading.

• Use stop-losses, trailing stop-losses, and position and portfolio management to keep your profit and loss at an exceptional level.

• Monitoring economic events, managing risk-to-reward, and placing a stop-loss can help you prevent big losses from unexpected events.