In volatile markets, it is more important than ever to pay attention to your investment portfolio. When a market is volatile, it experiences major rises and drops which can be attributed to market pressures, cost changes, and psychological effects on investors. Volatility means that the stock or fund is making unexpected changes based on the long-term trends of the investment.
Timing the market is a difficult proposition and best left to professional investors. Ram Lee, partner at Seven Bridges Advisors, a registered investment adviser in New York City, offers advice for investors who want to survive and thrive in a volatile environment.
Looking at Volatility
Volatility is the measure of how much a stock or security might raise or lower in price compared to its long-term baseline. The statistical method used is the standard deviation. For example, the S&P 500 has a standard deviation of about 15 percent. This means that the price could rise or lower by about 15 percent while remaining inside the bounds of expected movements. Other types of investments, like certificates of deposit, remain stable with standard deviations of zero.
The causes of volatility are not always known. Sometimes company news, other markets, day traders, and institutional investors may cause these prices to fluctuate wildly. Psychological factors may also cause volatility. This is understandable because the process of buying and selling is an emotional business. It is best to keep emotions out of stock and investment trading as much as possible, even when the markets are volatile. Operate based on statistical principles and you will find that you make a better return on your investments.
How to Invest in Volatile Conditions
Some investors choose to stay in for the long haul, ignoring all volatility. This can make a significant financial hit if the market makes a downturn. While it is likely that the stock market will rebound after a time, this represents a strong psychological blow to an investor’s confidence. Some investors who use this strategy ignore their investments until they are ready to cash them in, while others make small changes based on the movements of the market.
There is a common misconception that the “buy-and-hold strategy” over 10 years will always make a profit. The beginning and end points of any ten year period could be good for bad for stock markets. While most ten years periods have a positive return, certainly not all do.
Trading Tips for Volatile Markets
When markets move, there is often opportunity. Generally, most investors should look to rebalance their portfolios when the percentage allocations move out of whack with their long-term goals.
For example, if you plan to have a portfolio that is 70% in stocks and 30% in bonds, and your stock investments go up compared to your bond investments such that your portfolio is now 80% stocks and 20% bonds, then it’s likely time to trim your stock portfolio back some. In that case, a disciplined investor might sell stocks to bring their portfolio back in line with the 70%/30% long-term target. In contrast, should stocks go down and that same portfolio goes from 70% stocks to 60% stocks, it’s likely time to sell some of the bonds and reinvest in stocks after such a sell-off.
What Order Type Should I Make?
In a volatile market, it is smart to place a limit order, whether for an individual stock or an Exchange Traded Fund which is a more diversified pool of stocks. Limit orders may be a little bit more expensive than market orders, depending upon your broker, but they give you more certainty at what price you will be buying or selling. With a limit order, the brokerage will automatically buy or sell your stock at a preset number of shares and only when the price hits or goes past a certain threshold.
Stop orders can also be useful in making sure you sell a stock you have been meaning to trim if the price of that stock starts to drop. While stop orders can limit losses, they should be used on stocks you are willing to sell should the price drop, rather than buy more of them.
Both limit and stop orders will help you manage a volatile market, without having to be glue to your screen to watch your investments all the time.
Surviving a Volatile Market
Wide price swings can spook even the most seasoned investor. Using these tips from Ram Lee, investors should be able to avoid the worst consequences from their market moves and should be able to build wealth for the future.
Above all, investors should continue to monitor even their long-term investments in a volatile market.