Risk-Reward of Trading the Referendum is Horribly Skewed

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Risk-Reward of Trading the Referendum is Horribly Skewed

Risk-Reward of Trading the Referendum is Horribly Skewed

The Market and Political View from Adam Jepsen, Founder, Financial Spreads.

Like many market events, we have been looking at how investors could trade the referendum profitably.

For short-term investors it is tempting to trade the UK referendum, the volatility is appealing.

However, the volatility we could see over the next week could be of a different magnitude.

This probably makes the risk-reward ratio skewed to towards results of plain nasty, hideous or disastrous.

- - - Problem 1: What Will the Markets Do? - - -

The result of the referendum is far from clear.

Even if you correctly predict the result you then, as usual, have to predict the market reaction.

Theoretically, a win for the Remain campaign would boost the FTSE 100 and Sterling.

Of course, the theory quickly breaks down if the market has partially priced in that result.

It is often said that the financial markets will move in the direction that hurt the most people, this could be another example of that.

- - - Problem 2: Extreme Volatility - - -

Now it gets tricky.

There seem to be a lot of people and adverts saying this is a great trading opportunity but the wild swings could be too much for all but the deepest of pockets.

Even if you correctly predict the result of the referendum, and the broader market reaction, there will probably be a lot of volatility.

The markets could easily spike against your trade and close your position before you can make a profit. That would be plain ugly.

Of course, extreme volatility is a distinct possibility. If a markets moves against you it could gap to a completely different price level.

That could leave you in the hideous scenario of wiping out all the funds in your trading account.

Worse-still is a disastrous but plausible price move that leaves you in debt.

At the moment, the markets feel like a lot of tightly coiled springs.

Also, in the options markets it's realistic to assume there are some very big positions that could be triggered and send markets spiking.

George Soros's 1992 $10bn short of Sterling could be common place.

- - - Potential Solution: Sit on Your Hands - - -

A simple solution is to sit on your hands.

Forget trading the referendum, the risk-reward ratio is probably not in your favour.

Just watch Euro 2016, take up a hobby, learn how to play Minecraft, take care of that errand you've been putting off for two months or finish the DIY you've been putting off for two years.

There will be plenty of trading opportunities after the result has been announced and the markets have had a little time to calm down.

By Adam Jepsen, 15 June 2016

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