How to invest in a volatile market: 3 strategies
Market volatility can be nerve-wracking for investors. Discover three key trading strategies, plus the pros, cons and risks of trading in a fast-moving market.
If you know your way around the stock market, then trading when it’s shifting fast could be a profitable challenge. In this guide, we’ve covered what to consider when investing in a volatile market, and three popular strategies.
What is a volatile market?
A volatile market is one that looks like a steep roller-coaster. Share prices rise and fall significantly in a short time-frame – within hours, even. It’s a particularly thrilling ride for some investors, but it’s not for everyone.
Volatility is usually measured by “standard deviation”. Your trading platform may have indicators such as Bollinger Bands within its advanced charting features – these can help you see how volatile the market is. A Bollinger Band, for example, is based on a moving average price with a standard deviation band above and below this.
During market volatility, you typically see wide price variations and increased trading. More volatility in markets tends to indicate more risk. It’s worth checking to see if your broker has information on the volatility of stocks, or lists those that are currently volatile.
What causes a volatile market?
There can be a variety of factors at play. Sometimes, it can be one major factor, such as in the coronavirus stock market crash, and in other cases, it could be a combination of factors. These are some common causes:
- Economic releases
- Company news
- Initial public offerings (IPOs)
- Unexpected earnings results
MUST READ: Before you start trading in a volatile market
Make sure you’re aware of the added risks, and understand that you may see the value of your investments drop. It’s sensible not to invest more money than you can afford to lose, and to make sure your living expenses are covered.
How do I prepare for a volatile market?
If you want to prepare for a potentially volatile market then it’s smart to have a diversified portfolio. This means investing in different types of assets, different sectors or different countries, or all of these. That way, if there is volatility in a specific asset, country or sector, you have back-up investments.
It’s also worth thinking longer term. Volatility is like turbulence when you’re flying: it does pass, you just need to keep calm.
Lastly, it’s worth remembering that you don’t know when markets will become volatile. Don’t tell yourself that you’ll prepare for volatility later. It’s smart to take the steps you need to take now to ensure you’re prepared.
So, once you’re prepared, what strategies can you use when the market turns volatile? There are a few you could consider, and we’ve set out our top three below.
This speaks to the longer-term view. For this strategy to work, you’ll need a well balanced and diversified portfolio of investments that you plan to keep for the longer term. If you don’t have any investments, it’s probably not the best time to start.
You’ll also need plenty of years of investing ahead of you. If you’re going to need the money soon, ignoring volatility isn’t a sensible strategy.
If you do opt for ignoring, try not to look at your trading apps more often than you normally would, to help you avoid making rash decisions or panic selling.
Move your money to less risky investments
This strategy is generally a better option if you think you’ll need your money in the next few years or you panic if you see your investments starting to fail (although that’s a sign that you probably shouldn’t be investing).
Some stocks are known as “safe haven” investments, indicating that they tend to do better than other stocks when markets are going wild. Safe haven investments include government bonds, gold and currencies.
If you want less risk, consider moving your money into the types of investments listed below.
Government bonds are debts issued by the government. You’re essentially loaning the government money, and in return, it gives you a set amount of interest at regular periods. At the expiry date, the government gives you back your initial investment.
In times of volatility, gold tends to fare quite well. It’s an asset that people tend to turn to as a safer investment, typically as part of a diverse portfolio in times of uncertainty and while other stocks are on the decline.
This means that as long as people believe gold to be a safe haven and buy it because it’s a safe haven, it will be a safe haven.
Not all currencies are considered to be safe havens. It generally depends on how stable the government behind the currency is. The Swiss franc, for example, is thought to be a safe haven because the Swiss government has been pretty stable.
The euro, the US dollar and the Japanese yen are three more examples of currencies that are treated as a safe haven.
Defensive stocks (as opposed to “cyclical stocks”) are stocks for companies that cover basic needs, such as food, energy and water. During market fluctuations, people still need these items, which generally keeps the value of these stocks stable.
Some investors consider trading options in volatile markets. Options trading lets you “lock in” a price without the obligation to buy. You pay a premium for it, which means (like any investing) that it’s not risk-free. There are some options strategies that you can consider based on the ways you believe the stock prices will move. There’s more on this in our guide about options trading.
Pros and cons of trading in a volatile market
- Can be exciting, despite the uncertainty
- Can enhance your understanding of the stock market and test how diversified your portfolio is
- You tend to encounter more broker downtime during volatile markets
- If there are execution delays, you can find yourself paying a different price
- Riskier than traditional investing
Trading in a volatile market can be a roller-coaster in more ways than one. It’s a risky time to invest and it certainly isn’t for beginners. There can be great opportunities if you do your research. If you do go for this strategy, it’s worth looking at how diverse your portfolio is.
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
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