16 Aug 2019
What is Volatility?
Volatility describes the fluctuation of price change over a period of time. Instruments with low volatility exhibit relatively stable price movements, while markets with high volatility move sharply with erratic price movements, hitting new highs and lows quickly. Is Volatility Good For the Market? It’s important to remember that some volatility is natural. In fact, volatility is a trader’s friend, as it offers opportunities to set entry points at low prices and exit points at higher prices. The larger the degree of fluctuation, the more is the profit potential. On the other hand, the absence of volatility suggests highly stable prices, with rare opportunities to take profit and, even then, not meaningful enough. As with most good things, there are downsides. While volatility presents opportunities, it also poses risks. These risks are well understood by traders, who take them into account in decision making and diversify their portfolio to hedge risks. These opportunities and risks are two sides of the same coin and a natural part of trading. Having said that, there may be unnatural volatility, with prices fluctuating wildly and recording unprecedented highs and dramatic lows. Periods of high volatility pose unnaturally high risk and it may be wiser to wait for the market to stabilize a little before placing traders. So while every trade has the possibility of either success or failure, volatility decides the magnitude of these results. Without volatility, you are at a lower risk of making a loss, but are also at a risk of making very low profits. Below are some ways that can help you deal with volatile markets. Watch for Breakouts from Consolidations As long as an asset remains between the support and resistance of a tunnel, no action should be taken. In a volatile market, there is rapid fluctuation in prices. An upside breakout can lead to immediate and considerable high prices. This is the potential that breakouts in a volatile market offer, but these breakouts may change direction and cause severe damage to the price of the asset the trader is long on. So, it is prudent to use stop-loss and take profit orders to limit losses. Consider Shorter-term Strategies During periods of high volatility, one way to take advantage of price fluctuations is to look at quick entries and exits. However, this should only be done if you have the knowledge, experience and time to closely follow the market movements. On the other hand, risk averse traders may choose to wait out times of high volatility and avoid making decisions that could be emotionally driven, such as out of apprehension or fear. Dealing with Volatility in the Market 1. Diversification of Portfolio This is one of the most effective ways to manage volatility. Invest in a variety of assets and industries for sustainable and stable results over time. This way volatility in one market will not wipe out all your savings, since its impact will be mitigated by stability in other markets or instruments. 2. Look at the Bigger Picture Ignore the short-term mayhem in the prices of assets and wait for the markets to stabilise again. It is difficult to determine when to enter and exit during times of volatility and bad timing could further increase your losses. 3. Invest Systematically If the market has collapsed, some traders see it as an opportunity to invest at lower prices. Instead of trading randomly around market events, professional traders tend to trade on a regular basis and react to what is happening at the time in the markets. Having a well thought out strategy is the best way to get through periods of uncertainty in the market. If you are willing to take risks, volatility might not be bad at all, as long as you are prepared with the right risk management strategies. Reference Links https://www.schwab.com/active-trader/insights/content/how-traders-can-take-advantage-volatile-markets https://www.investopedia.com/articles/02/051502.asp https://www.northwesternmutual.com/life-and-money/what-causes-volatility-in-the-markets/ https://www.investopedia.com/terms/v/volatility.asp https://americanfundsretirement.retire.americanfunds.com/basics/volatile-market/dealing-with-volatility.html