Thin Markets Unnerve Traders: What to Know About Summer Trading

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Low trading volume is the market theme of the summer, which is driving investors to question their knowledge and ability to move in and out of markets. Forex, stocks, commodities and even crypto — they all seem more volatile during the summer quarter and there’s a reason for that.

Big-shot traders ditch the trading desks for margaritas, espresso martinis and tan on the Amalfi coast while algo trading gets to slosh around billions of dollars. The result — thin liquidity sinks trades every now and then.

August Trading Shakes and Stirs Markets

The summer months have rolled in and with them a heightened feeling of unease has swept global markets. From a rally in the Japanese yen, to a big meltdown in stocks and crypto market carnage, asset classes got shook from this one market characteristic — volume.

Thinning trading volumes disrupted the usual market rhythm, ushering in an environment dominated by increased volatility and unpredictable swings. Low volumes have the tendency to amplify price declines and increases.

Illiquid August conditions may turn a rather normal move into a violent swing. Fewer shares traded means that a trading instrument is more susceptible to sharp price movements as there are fewer participants to absorb the trades.

Panic Selling and the Carry Trade

A volatility storm swept Japan’s stock market last week, throwing it into its worst single-day performance since 1987. Japan’s broad-based index Nikkei NI225crumbled 12.4% in a single session while US stocks slumped 3%. Wall Street’s fear gauge, the VIX index of volatility VIX, shot up more than 50% to its highest level in 2020 when the pandemic was wreaking havoc.

A day later, Japan bounced up 10% and the S&P 500 jumped 1%. The VIX shot lower by 28%. Japan ended up in the spotlight due to the unwinding of what’s called the “carry trade” — big hedge funds had borrowed trillions of cheap Japanese yen at near-zero interest rates to buy stocks or jam the cash into Treasury bills that pay a 5% interest. Risk-free.

What’s not to like? The yen’s rise, for one. The sharp appreciation of the yen sent panicked carry traders scrambling to dump their holdings and repay their yen debt, which was getting more expensive.

It’s the Algos’ Market, We All Live In It

In August, traders typically exchange about 9.3 billion of US shares a day. Compared to March, where 13.2 billion shares change hands a day, that’s a 30% decrease in trading volume. Apparently, Wall Street does get a break from trading. Or does it?

The stock market and the currency market, in particular, are dominated by and large by computer-trading algorithms that execute trades at lightning speed based on pre-programmed criteria. These algorithms, or simply algos, are allowed to process huge amounts of data and react to market conditions in milliseconds.

While this can create efficiency and liquidity in normal market conditions, during periods of low volume — such as the summer months — they can contribute to increased volatility, especially if they are levered to the tune of 15, 20, 30 times.

A single large order or a sudden piece of news can trigger a cascade of algorithmic responses, leading to rapid and sometimes exaggerated price movements. In other words, when these algos make a decision, that’s when volatility goes through the roof. Pair it with low volumes and you’ve got an explosion (or implosion) of prices.

How to Survive Wild Markets?

Given the unique challenges of summer trading, traders need to adjust their strategies accordingly. Here are some tips that can help.

Lower Position Sizes: In a thin market, large positions can be harder to exit without moving the market (especially if you’ve loaded up on illiquid meme coins). Reducing position sizes can help mitigate this risk.

Wider Stops: With increased volatility, it may be necessary to widen stop-loss orders to avoid getting wiped out by intraday market noise.

Focus on Liquidity: Stick to trading more liquid instruments where possible, as these will typically be less affected by the summer slowdown. Hint: forex is the most liquid market.

Keep an Eye on Economic Data: Summer doesn’t stop economic data releases, which can lead to outsized market reactions in a light market. Stay informed.

Patience and Discipline: Summer trading requires patience and discipline. The temptation to overtrade in a quiet market can lead to mistakes. It’s often better to wait for clearer setups rather than forcing trades in a challenging environment. While you're waiting for the right moment to step in, test your strategies and find the best moves for future trades.

What Do You Think?

Summer trading presents a unique set of challenges that can unnerve even the most experienced traders. Thin markets, increased volatility, and the dominant role of algorithmic trading create an environment where caution is paramount.

How do you handle volatile markets in thin trading? Let us know in the comments and let’s spin up a nice discussion!