The stock market is a “fascinating creature”. Every day, it moves up and down, up to any extent, and without warning. This often drastically affects the lives of those who have investments in it. Why does this happen? What are the implications for me? And how can I protect myself from volatility? We’ll answer all these questions and more in this post!
The volatility of the market can be frightening, but with knowledge, you will be better prepared to deal with it. In this post, we will outline what volatility is, and how you can prepare for its effects on your investments.
Why volatility of the market is crucial for trading?
Volatility is a fundamental concept in the field of finance. Most people believe it is the most crucial factor for successful trading. It is a self-evident statement that it will be impossible to make profitable trades if volatility increases, but so what? We can still improve our performance by understanding how the volatility of the market affects trading and knowing how to deal with it.
Also, volatility is a way you can measure the efficiency of a trading system. If you have made a trade on the basis of your system, you will know whether that trade was risky or profitable. Taking into account your trading strategy is key to determining which system works for you and other traders. If your trades outperform others, then it’s worthwhile to take that into account when determining which trading system will be most successful.
Also Read: Do people manipulate the Forex market?
Knowing how the volatility of the market works
It is all about expectations, isn’t it? If you expect that the price of something will go up in the future, you will buy at a lower price and sell at a higher one. In other words, when your expectations are higher, you are willing to pay more for something today, and thus volatility increases. It is easier to sell now at a higher price than to buy later at a lower price if you expect that the price will go down in the future. Therefore, when you expect less volatility, you are more likely to buy at a lower price in the future. However, this might not be the whole picture.
There is not necessarily a correlation between actual performance and actual expectations. It can be very good to buy something that is expected to go up in the future and increase its value, but it can be very bad if you buy something that is going down. If your expectations are wrong, volatility will make you lose much more than if they were correct. Therefore, when you expect that a stock will go down and it actually does go down, or when you expect it to go up and it actually goes up – then volatility was your enemy. You lost money due to your incorrect assumption.
The stock market is driven by supply and demand, which affects the price of all market assets. Each asset has its own special characteristics – for example, the price of gold fluctuates more than other metals because it is considered a safe investment with no dividends or interest payments.
If you know how volatility works, you are likely to succeed in trading.
How can I deal with volatility and Profit from it?
Let’s say that, for some reason, a company is going down and you expect it to go down even more in the near future. Should you sell the stock now and wait until the price goes back up? That would be an “aggressive” strategy and it might not work well. Instead, we should try to understand how volatility works and how we can profit from it as much as we can. So our first step must be to prepare ourselves for higher volatility:
1) We need to add some money to our portfolio that would help us hold on when the market does go down.
2) When we have some extra money in our account, we should buy some shares on the higher side of the current price.
3) When the price goes down, we sell our shares and use the money to invest in something else.
4) As time passes, the stock will regain its value. That’s when we can sell it at a lower price and enjoy a profit from our higher expectations.
The result of this strategy could be that you buy at $100 and sell at $115. In other words – you made a profit of 15%.
To profit from market volatility, you should be able to identify the specific patterns and trends that are indicative of a large price movement. It even has its own jargon: “a bull market is typically characterized by lower variability than a bear market”. The reason for this is that during bull markets, both buyers and sellers have more confidence in the potential for investors to make higher profits in their investment portfolios. Therefore, it will be more, highly competitive than during bear markets, as fewer sellers enter or exit the market at any given time.