Over the last few months, there has been a meaningful spike in market volatility as well as negative equity and bond returns. But panic is never a good strategy. Read on for strategies to consider when volatility strikes.
The market is constantly in flux. Investors are well aware that bull runs and downturns are common occurrences, but they also know that periods of extreme volatility can wipe out previous gains and more.
While there are many different ways to approach the market in times of such volatility, some investors may find it useful to use non-directional or probability-based trading methods during periods of extreme volatility. Here is a look at some strategies that could help you protect your assets from potential losses and profit from rising volatility.
Volatility and Risk
Volatility and risk are two terms that are often used interchangeably, but they actually have very different meanings. Understanding the difference between volatility and risk is an important step when it comes to deciding on which trading method you should use.
Volatility in the financial markets is the quantification of the speed and magnitude of an asset's price swings. Any asset that sees its market price move over time, has some level of volatility. The greater the volatility, the larger and more frequent these swings are.
Risk, on the other hand, is the possibility of losing some or all of an investment. There are several types of risk that can lead to a potential loss, including market risk (i.e., that prices will move against you).
As the volatility of the market increases, market risk also tends to increase. In response, there can be a marked increase in the volume of trades during these periods and a corresponding decrease in the holding periods of positions.
Volatility can be hard to predict, and it can be even harder to manage correctly. Luckily, volatility can be hedged away… to some degree.
Hedging Against Volatility
Determining an investment strategy on how to invest when the market remains extremely volatile will lower your risk and avoid large losses. To protect against volatility, investors can buy protective put options. Protective put options are a type of insurance that allows the holder to sell shares of the underlying at a set price on or before the contract expires.
Another way to hedge against volatility is to sell shares or set stop-loss orders to automatically sell them when prices fall by a certain amount. However, this can create taxable drawbacks and removes the investments from your portfolio. For a buy-and-hold investor, this is often not the best course of action.
Instead, investors can buy protective put options on either the single stocks they hold or on a broader index such as the S&P 500 (e.g., via S&P 500 ETF options). A put option gives the holder the right (but not the obligation) to sell shares of the underlying as a set price on or before the contract expires.
Diversify, Diversify, Diversify.
Diversification is a technique that reduces risk by allocating investments across various financial instruments, industries, and other categories. It aims to minimize losses by investing in different areas that would each react differently to the same event.
Diversification is a staple of investing. But as markets change, your portfolio may need to evolve. Times of volatility offer a great opportunity to reevaluate and possibly rebalance your asset mix.
When stock markets start tumbling, daily injections of bad news may sound like it will never end. It can spark anxiety, fuel uncertainty and trigger radical decisions in even the most seasoned investors.
What’s important is that you understand your situation and your financial plan. One key to living with market volatility is focusing on long-term results rather than the daily bumps along the way. Staying the course can be difficult, but it can also create opportunities. You can speak with your trusted financial advisor at NJM to learn more.
How NJM Can Help
Not everyone's investment strategy will be the same. But having a strategic approach to investing can help you maximize your retirement income while minimizing your investment taxes.
Fortunately, Nic McLeod Wealth Preservation can help you develop a goal-driven plan to help you achieve your investment goals. Nic is a second-generation Wealth Preservation Specialist. He has nearly 20 years of experience, and his client base is diverse in both their professional backgrounds and financial needs.
At NJM, we have a record free of any consumer complaints—a direct result of the core values at McLeod Wealth Preservation. You can find more information on NJM’s wealth management services here.
If you would like to begin your investment journey, contact us to set up a consultation today.