During Market Turmoil, Here’s How Knock-Outs Can Help With Your Trades
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The investments in my portfolio that I once deemed unshakeable are in the red, and key indices like the Wall Street Index (.DJI) have been on a downward slide.
Since peaking on 12 Feb 2020, the .DJI has since fallen as much as 37% (23 March 2020) — the lowest point to date since the stock market downturn in the early 2000s. It’s no wonder traders and investors have been panic-selling, in hope to cut their losses.
Earlier that week, US oil prices crashed as much as 34%, hitting a 4-year low. Crude, too, took a beating, plummeting 24%. An oil price war broke out, when Russia refused to curb production and Saudi Arabia increased production in response.
Even Wall Street has been hit badly. And on 17 March, the Philippines announced it would shut financial markets.
I’m half-panicking, because my investments have dived 20% so far, and are still going down. They are now a good 7% below the launch price. A friend of mine, who has 30 Grand in an Australian bank, saw it weaken by over 10% against the Singapore Dollar in just a few weeks.
However, there are still opportunities in the market. Yes — you can still trade while managing your risk (and maybe turning a tidy profit) in this volatile market.
Knock-Outs (KOs) might just be a good candidate. Just launched last year by online trading brokerage IG, trading KOs lets you manage the amount of risk you take. A type of CFD, KOs are limited-risk positions that enable you to trade on higher leverage and lower risk on forex, indices and commodities.
Let’s look at how KOs can help with your trades:
Knock-Outs are good for managing risk
As mentioned, KOs are a risk-limited product. This makes them good for times of huge volatilities, such as during the coronavirus pandemic.
With KOs, you can take control of your margins and risks, so you can only lose what you initially put in, and nothing more. This means a sudden movement of the market in the wrong direction won’t send you deep into debt.
That’s because with KOs you have a Knock-Out level (hence the name) akin to a guaranteed stop which gets triggered when it hits your Knock-Out level, closing your trade. This makes it a good hedging tool against market fluctuations, especially during times where oil prices drop.
Knock-Outs allow you to go short or long
While the market is on a downward spiral, you can still trade KOs by shorting the market. To buy a Knock-Out, you can choose to either buy Bull KOs or Bear KOs.
Bull KOs allow you to go long, while Bear KOs allow you to go short. In simple terms, you buy a Bull KO if you think the market is on an uptrend, or a Bear KO if you think the market is on a downtrend.
Say for example, you bought a Bear Knock-Out and the market continues to fall; you will earn the difference when your trade is completed. However, if the market picks up, then you’ll lose money up to your KO level (or less, if you stop the trade prior). And vice versa.
You control your maximum loss from the beginning
Right from the start, you can specify a Knock-Out level. For example, if the underlying asset is currently trading at an offer price of 3170, and you expect the price to go up, you can buy a Bull Knock-Out and set the Knock-Out level at 3155.
There’s no limit to what you can earn, for example if the offer price shoots up to 4000. However, if the underlying asset unexpectedly falls, your Bull Knock-Out level of 3155 will immediately stop your losses at 3155 — even if the price drops to 3000 or less.
Your maximum loss cannot exceed your margin, and you won’t lose more cash than you have on hand.
Here’s a simple calculation:
Your emotions don’t get involved
Unlike those who are panic-selling their stocks as the ship seems to sink under their feet, KOs help you keep a level head during market turmoil.
Sure, while monitoring the trade, our hearts may still leap at the slightest movement, but KOs prevent us from making trading decisions based on our emotions.
Remember that day in February when the S&P 500 slid 2 days in a row? It was the worst drop for the index since August 2015. To date, S&P 500 portfolios have been decimated by over 20%. Be still, my heart.
But you can stay rational with KOs, because KOs limit your losses. While there are products out there like Guaranteed Stops that allow you to keep adjusting the level — KOs demand that you lock in the KO level from the beginning.
No changing your mind, okay? If you’re going to make a loss, KOs control it. They don’t “give chance” and allow you to keep adjusting the level while praying for a miracle recovery, only to end up deep in debt.
Knock-Outs let you trade on higher leverage
In all honesty, leverage products are scary. Because the leverage multiplier also applies to your losses as much as your gains.
However, as discussed above, KOs allow you to control your losses, and your maximum loss cannot exceed your margin, so you won’t lose more cash than you have on hand.
With KOs, depending on your own risk tolerance, you can set leverage ratios on every single trade — even if they are multiple trades on the same asset.
This allows you to hold short-term positions on the same asset while still hedging risk with a longer-term position on the same asset. This strategy could result in unlimited upside while hedging against losses.
If your risk appetite is small, set a KO level at a greater KO distance, which creates lower leverage. A KO distance of 5% would give you a 20:1 ratio on a longer term KO position that can be held over a few weeks or months.
If you have a bigger appetite for risk, set a KO level with a shorter distance like 1%, to create higher leverage (100:1 ratio). This is useful if your trading strategy targets short-term volatility or market movements as a result of macroeconomic news.
You can ride new market trends
If you are a trader that wants to ride new market trends or dabble experimentally in the market, KOs allow you to do so with minimal risk. You won’t lose more cash than you have on hand.
With KOs, you also have the ability to take advantage of volatile situations as mentioned earlier, while controlling your losses should the market not be in your favour.
By the way, did you know that IG is the only CFD broker to offer KOs in Singapore?
To find out more about alternatives to FX trading, check out IG’s Bloomberg ebook, which also includes a chapter on Knock-Outs.
This advertisement has not been reviewed by the MAS. The information in this article is meant for informational purposes only and should not be relied upon as financial advice. Users may wish to approach a financial advisor before relying on any advice provided by the website to make any decision to buy, sell or hold any investment product. Contracts for Difference (CFDs) are speculative products. The leveraged nature of CFDs involves the risk of losing substantially more than your initial investment.