Investment Strategies for Traders in Volatile Markets

As a result of volatile markets, many investors become frightened and begin to question their investment strategies. In particular, novice investors may be tempted to withdraw from the market entirely and wait until it appears safe to re-enter the market.

The important thing to remember is that market volatility is unavoidable. The stock market’s natural tendency is to fluctuate up and down in the short term. It is extremely difficult to predict when the market will peak. One solution is to maintain a long-term perspective while ignoring short-term fluctuations in the market.

The strategy works for many investors, but even long-term investors should be aware of the risks associated with volatile markets and the steps they can take to protect themselves from these risks. Exactly how to accomplish this will be demonstrated in this article.

The Most Important Takeaways

  • Over the short term, market volatility is unavoidable; it is inherent in the nature of the markets to fluctuate up and down.
  • A volatile market is one that is characterized by large price fluctuations and a high level of trading activity.
  • To deal with volatility, one strategy is to avoid it altogether; this means remaining invested and not paying attention to short-term fluctuations in the market.
  • Limit orders, which are orders placed with a brokerage to buy or sell at a price that is lower than or equal to a specified price, are your best friend when trading in a volatile market.

What Is the Definition of Volatility?

When it comes to markets or securities, volatility is a statistical measure of the tendency for them to rise or fall sharply in a short period of time. The standard deviation of the return on an investment is typically used to measure it in financial markets. The standard deviation is a statistical concept that denotes the amount of variation or deviation that can be reasonably anticipated in a given situation.

In the case of the Standard & Poor’s 500 Index (S&P 500), the standard deviation could be as high as 15%1, whereas a more stable investment, such as a certificate of deposit (CD), will typically have a standard deviation of zero because the return never changes.

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A volatile market is one that is characterized by large price fluctuations and a high level of trading activity. They are frequently the result of an imbalance in the number of trade orders in one direction (for example, all buys and no sells). Economic data releases, company news, a recommendation from a well-known investment analyst, a popular initial public offering (IPO), and unexpected earnings results, according to some, are the root causes of volatile stock markets. Others hold day traders, short sellers, and institutional investors responsible for the volatility.

One possible explanation is that investor reactions are influenced by psychological forces of some sort. This theory is in direct opposition to the efficient market hypothesis (EMH), which states that market prices are correct and adjust to reflect all information in real time. According to this behavioral approach, significant price changes (volatility) are the result of a collective change of mind among the general investing public. It is clear that there is no consensus on what causes volatility; however, volatility exists, and investors must learn how to deal with it. The bottom line is that volatility exists, and investors must learn how to deal with it.

Investing in a Market That Is Highly Volatile

A good way to deal with volatility is to stay away from it entirely. This entails remaining invested and not paying attention to short-term fluctuations in value. This can be more difficult than it appears; watching your portfolio take a 50% hit during a bear market can be more than most people can bear.

It’s a common misconception that investing in stocks for a long period of time will result in profits. But this is not true. Because markets are driven by corporate fundamentals, long-term investing still necessitates extensive research. In the event that you find a company with a strong balance sheet and consistent earnings, the short-term fluctuations will have little impact on the company’s long-term value. Even periods of high volatility may be an excellent time to invest in a company if you believe it is well-positioned for the long term.

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The primary argument in favor of the buy-and-hold strategy is that missing out on the best few days of the year will result in a significant reduction in your return. According to the source of the data, the statistic will typically sound something like this: “Missing the best 20 days could reduce your return by more than half.” This is, for the most part, accurate. On the other hand, missing the worst 20 days will significantly increase your portfolio, and in some cases, you may want to make trades during volatile market conditions in order to maximize your returns.

When there is a lot of volatility, how does trading suffer?

Investors, particularly those who use an online broker, should be aware that, during periods of high volatility, many firms implement procedures that are intended to reduce the firm’s exposure to extraordinarily high levels of market risk.

Example: Historically, some market-maker firms have temporarily suspended their normal automatic order executions and instead handled orders by hand rather than automatically.

In addition, the way securities are executed during periods of high volatility and high volume differs in a number of other ways. The following are some important points to be aware of:

Market volatility is associated with high levels of trading activity, which can result in delays in the execution of orders. Because of the high volume of orders, it is possible that executions will take place at prices that are significantly different from the market price quoted at the time the order is placed.

During times of high volatility in the market, investors should question market makers about how they handle order executions. Because of the widespread use of online trading, we have come to expect prompt executions at prices that are equal to or close to the quotes displayed on our internet-connected devices. It is important to remember that this is not always the case.

Digital Mayhem: Due to the limitations of a system’s capacity, you may experience difficulties in executing your trades. Additionally, if you are trading online, you may have difficulty logging into your account due to high levels of internet traffic on the day you trade. In order to address these concerns, most online trading firms provide alternatives such as phone trades or speaking with a broker over the phone to place an order.

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Inaccurate quotations: It is possible that there will be significant price differences between the quote you receive and the price at which your trade will be executed when you trade.

Keep in mind that, in a volatile market environment, even real-time quotes may be several minutes or hours behind what is currently happening in the marketplace. The number of shares available at a specific price (known as the size of a quote) may also change quickly, affecting the likelihood that you will be able to purchase shares at the quoted price.

In a volatile market, selecting an order type can be difficult.

When the markets aren’t moving in the manner that they normally do, the type of order you place is extremely important. Market orders will always be executed, but in fast markets, you may be surprised by the price you receive, which may be significantly different from the price that was quoted in the first place.

If you are trading in a volatile market, limit orders – orders placed with a brokerage firm to buy or sell a predetermined number of shares at or better than a predetermined price – are your best friends. Despite the fact that limit orders are slightly more expensive than market orders, they are always a good idea to use because the price at which you will buy or sell securities is predetermined. On the downside, a limit order does not ensure that your order will be executed.

What’s the bottom line?

During periods of high volatility, investors must be cognizant of the risks that they may face. Making the decision to remain invested can be a wise decision if you are confident in your investment strategy. If, on the other hand, you decide to trade during a period of increased volatility, be aware of how the current market conditions will affect your trade.

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