By Deepak Jasani
Financial market volatility is not as bad as it is portrayed to be. There are earning opportunities for investors and traders. Without volatility there would be no price movements and therefore no profits. However, very high volatility increases the risk of loss. Therefore, learning to manage volatility is crucial to maximizing investment success. First, accept volatility and join them. 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:
Economic indicators
Economic reports like GDP, inflation data, consumer price index, etc. have a significant impact on the markets. Investors follow economic calendars to stay up to date with economic data from domestic and international economies. The economic calendar also contains analyst forecasts on such dates. Positive or negative surprises compared to these expectations can also lead to price volatility.
Geopolitical events
International conflicts, political instability and trade wars create uncertainty on a global level, leading to volatility. For example, since the Israeli-Palestinian conflict began in the first week of October 2023, gold prices, which had been on a downward trend, began to rise.
Results reports
Public companies’ earnings reports are published quarterly, along with their forecasts for the next quarter or full year. These announcements have a strong impact on investor sentiment, resulting in increased volatility in the related stocks and indices or the stocks of the sector to which the company belongs.
Interest rate decisions
Changes in monetary policy affect borrowing costs, which ultimately affect business spending and are passed on to consumers. Disruptions in consumer behavior directly affect the supply-demand relationship and therefore the prices of goods and services, triggering market volatility. They also change future value discounting, which affects the valuation of stocks and indices.
Global events
Events such as natural disasters, pandemics, banking crises, etc. that spread across national borders have a strong impact on volatility due to changes in consumer sentiment.
Investor sentiment
The most influential factor influencing volatility is investor sentiment. The impact of an event on financial markets is only as strong as the magnitude of the change in investor sentiment. Any event that triggers fear, greed, or herd mentality is bound to increase price fluctuations.
How does volatility help investors?
While traders take advantage of the frequency and size of smaller price swings, investors take advantage of the larger moves that occur over the longer term. Here’s how.
Volatility is the lifeblood of trading
Traders want to make money by taking advantage of multiple price movements over a short period of time. It would be virtually impossible to profit from flat markets. Traders carefully enter long or short positions based on their price predictions. The higher the volatility, the greater the opportunities to enter and exit positions and optimize returns. However, higher volatility also means higher risks, which is why risk management strategies are invaluable in protecting your capital.
Investors look for volatility to get in
Investors want to benefit from the “buy low, sell high” philosophy. In the long term, financial markets tend to rise. Investors are trying to capitalize on this. As simple as it seems, investors can’t just buy at any point in time. They look for opportunities for sharp downturns, where any upswing can generate significant profits. Additionally, they ensure that their portfolio is diversified so that if certain assets underperform, the outperformance of other assets mitigates the losses. Investors use fundamental analysis to add poorly correlated or uncorrelated assets to their portfolio.
6 Tips to Manage Market Volatility
Dealing with market volatility requires small changes to your financial mindset and a little planning.
- Keep track of things
Upswings and downswings are inevitable. Markets cannot maintain a consistent direction forever. Investors must learn to ignore short-term volatility while traders must learn to exploit it.
- Create a strong investing/trading plan
Include volatility-related risk management measures in your financial growth plan. Align your investment plan with your financial goals and time frame. Stick with the strategy regardless of market conditions.
- Diversify
Diversify your portfolio to include different instruments. Evaluate the market using fundamental and technical analysis to determine which assets (preferably uncorrelated or low correlated) you should include in your diversification strategy to meet your financial goals, time frame and risk tolerance.
- Avoid emotional decisions
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 sizing, risk management, or investing/trading style.
- Assess and manage risks
To make informed financial decisions, it is important to know your risk tolerance. This allows you not only to ensure that losses do not exceed your financial capabilities, but also to take appropriate measures to hedge positions.
- Focus on your long-term financial goals
Trading and investing have a common goal: building wealth. This requires consistent efforts with the end goal in mind. Traders and investors must not deviate from their goals and strategies due to volatility, but rather learn to adapt and incorporate volatility management into their investment strategy.
Volatility can be both your friend and your enemy. Make sure you learn as much as possible about the assets you choose to make the most of price movements.
(Deepak Jasani is Head of Retail Research at HDFC Securities Ltd. The views expressed are the author’s own. Please consult your financial advisor before investing.)
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