Whipsaw in trading

Whipsaws in trading are sudden market movements that occur in volatile conditions and can trap traders in losing positions. Find out how to avoid whipsaws.

What is a whipsaw?

A whipsaw is a drastic increase or decrease in a market trend, which results in large losses for a trader that has recently opened a position. The move is so sudden and unpredictable that any previous analysis used to inform the trade is irrelevant.

There are two types of whipsaws:

Upmarket whipsaw – occurs when the price first breaks out upward, and indicators confirm the rally, but it’s followed by a drastic downward move
Downmarket whipsaw – occurs when a price falls in value briefly, and indicators confirm that decline, but it’s followed by a surge upward

In both situations, the price ends up trading nearer to its original price.

How to identify whipsaws

Whipsaws in trading are difficult to identify, but they usually happen in extremely volatile market conditions, where the price moves sharply without apparent reason.

A lot of whipsaws occur when prices are shown as overbought or oversold, but the trend continues despite the signals being given by indicators. This happens in periods of irrational exuberance, where traders can believe that a bullish or bearish run will continue indefinitely.

When more and more traders pile into a move, ignoring analysis, the market can become overheated. As prices move further away from their true value, the chance of a sudden reversal increases.

For example, say a stock is trading at $350 and indicators show its price is overbought. But traders continue to believe in the stock’s potential and continue buying. So, its price shoots up to $400. Suddenly, the market reverses to $320. These sharp movements are a whipsaw.

Had a trader opened a long position based on the indicator signals, they’d potentially face large losses without the proper precautions.

How to avoid whipsaw in trading

Since it's so difficult to predict, there’s no way to avoid the whipsaw entirely. But you can cap the losses that may occur by attaching a stop-loss order to your positions.

Stop losses automatically close a position if the market turns against the trade by a certain amount. This limits losses but it would also mean that if the market regains momentum in the original direction, the position would’ve been closed.

From time to time, StoneX Financial Pty Ltd (“we”, “our”) website may contain links to other sites and/or resources provided by third parties. These links and/or resources are provided for your information only and we have no control over the contents of those materials, and in no way endorse their content. Any analysis, opinion, commentary or research-based material on our website is for information and educational purposes only and is not, in any circumstances, intended to be an offer, recommendation or solicitation to buy or sell. You should always seek independent advice as to your suitability to speculate in any related markets and your ability to assume the associated risks, if you are at all unsure. No representation or warranty is made, express or implied, that the materials on our website are complete or accurate. We are not under any obligation to update any such material.

As such, we (and/or our associated companies) will not be responsible or liable for any loss or damage incurred by you or any third party arising out of, or in connection with, any use of the information on our website (other than with regards to any duty or liability that we are unable to limit or exclude by law or under the applicable regulatory system) and any such liability is hereby expressly disclaimed.

City Index is a trading name of StoneX Financial Pty Ltd.

The material provided herein is general in nature and does not take into account your objectives, financial situation or needs.

While every care has been taken in preparing this material, we do not provide any representation or warranty (express or implied) with respect to its completeness or accuracy. This is not an invitation or an offer to invest nor is it a recommendation to buy or sell investments.

StoneX recommends you to seek independent financial and legal advice before making any financial investment decision. Trading CFDs and FX on margin carries a higher level of risk, and may not be suitable for all investors. The possibility exists that you could lose more than your initial investment further CFD investors do not own or have any rights to the underlying assets.

It is important you consider our Financial Services Guide and Product Disclosure Statement (PDS) available at www.cityindex.com/en-au/terms-and-policies/, before deciding to acquire or hold our products. As a part of our market risk management, we may take the opposite side of your trade. Our Target Market Determination (TMD) is also available at www.cityindex.com/en-au/terms-and-policies/.

StoneX Financial Pty Ltd, Suite 28.01, 264 George Street, Sydney, NSW 2000 (ACN 141 774 727, AFSL 345646) is the CFD issuer and our products are traded off exchange.