How to Navigate Volatility?

By Deepak Jasani

Volatility in the financial markets is not as bad as it is made out to be. It gives rise to opportunities for investors and traders to earn. Without volatility, there would be no price moves, which would mean no profits. However, very high volatility increases the risk of losses. Therefore, learning to navigate volatility is essential to maximizing investing success. To begin with, accept and befriend volatility. Read on to learn what to do next.

Know What Stimulates Volatility

Financial instruments are influenced by various factors that affect price movements. These factors are broadly divided into the following categories:

Geopolitical Events

International conflicts, political instability, and trade wars create uncertainty at a global level, which triggers volatility. For instance, since the Israel-Palestine conflict began in the first week of October 2023, gold price, which was on a downward trajectory, started rising.

Earnings Reports

Earnings reports of companies listed on stock exchanges are released every quarter, along with their guidance for the next quarter or the full year. These announcements greatly impact investor sentiments, which translates into increased volatility in the associated stock and index, or stocks of the sector the company belongs to.

Interest Rate Decisions

Monetary policy changes impact borrowing costs, which eventually affect business expenses and are passed on to consumers. Disruptions in consumer behavior directly affect the demand-supply ratio and hence the price of goods and services, triggering market volatility. They also alter the future value discounting affecting the valuation of stocks and indices.

Global Events

Events such as natural disasters, pandemics, banking crises, etc that spread across nations greatly affect volatility due to changes in consumer sentiment.

Investor Sentiment

The single most impactful influencer of volatility is investor sentiment. The impact of an event on the financial markets is only as powerful as the size of the move in investor sentiment. Any event that triggers fear, greed, or herd mentality is bound to exacerbate price swings.

How Does Volatility Help Investors?

While traders harness the frequency and size of small price swings, investors leverage the larger moves that occur over the longer term. Here’s how.

Volatility is the Lifeblood of Trading

Traders aim to make money by exploiting multiple price movements over a short duration. It would practically be impossible to profit from flat markets. Traders carefully take long or short positions, based on their price predictions. The higher the volatility, the greater the opportunities to enter and exit positions and optimize earnings. However, higher volatility also means higher risks, which makes risk management strategies invaluable to protect your capital.

Investors Seek Volatility to Enter

Investors aim to profit from the “buy low, sell high” philosophy. In the long term, the financial markets tend to rise. This is what investors try to capitalize on. As simple as it seems, investors cannot just buy at any point. They look for occasions of sharp downturns, from where any upswing can generate significant profits. Plus, they ensure that their portfolio is diversified so that when certain assets underperform, the outperformance of other assets mitigates losses. Investors use fundamental analysis to add poorly correlated or uncorrelated assets to their portfolios.

6 Tips to Navigate Market Volatility

Navigating market volatility requires making small changes to your financial mindset and a little planning.

Keep perspective

Upturns and downturns are inevitable. The markets cannot maintain a single direction forever. Investors must learn to ignore short-term volatility, while traders need to learn to take advantage of it.

Build a strong investment/trading plan

Include volatility-related risk management measures in your financial growth plan. Align your investment plan with your financial goals and timeframe. Stay with the strategy regardless of market conditions.

Diversify

Diversify your portfolio to include diverse instruments. Assess the market with fundamental and technical analysis to determine which assets (preferably uncorrelated or low correlated) to include in your diversification strategy to meet your financial goals, timeframe, and risk appetite.

Avoid emotional decision-making

Base investment/trading decisions on thorough fundamental and technical analysis. Build a strong psyche to prevent emotions from influencing your entry and exit decisions, position sizes, risk management, or investing/trading style.

Evaluate and Manage Risk

Knowing your risk appetite is essential for informed financial decisions. It not only helps you ensure that losses do not go beyond your financial means to withstand while allows you to take appropriate measures to hedge positions.

Stay focused on your long-term financial goals

Trading and investing have one common goal – building wealth. This requires consistent effort while keeping the end goal in mind. Traders and investors must not deviate from their goals and strategies due to volatility but learn to adapt and include volatility management in their investment strategy.

Volatility can be both your friend and foe. Make sure to learn all you can about your chosen assets to make the most of price moves.

(Deepak Jasani is Head of Retail Research at HDFC securities Ltd. Views expressed are the author’s own. Please consult your financial advisor before investing.)