Investment Strategies For Volatile Markets

Market volatility can wreak havoc on your portfolio. Typically, market volatility refers to any unpredictable and sudden price movements, such as a sharp rise or fall in prices. These changes can seem unsettling and may lead to panic. In fact, panic selling is often associated with volatility. Market volatility can be particularly worrying for new investors who lack the necessary market know-how. However, even experienced investors can sometimes struggle to keep their investments and focus on the long-term goal.

The critical thing to note here is that market volatility is unavoidable. The market works in a cycle, and periods of boom are followed by periods of lull. This mechanism helps you earn profits and build wealth. So, instead of fearing market volatility, it is good to understand how it works, so you can embrace it to make better investment decisions. As far as volatility is concerned, it is usually the fear that may get the best of you. Pulling out early to avoid further losses may seem like the obvious solution, but there are some other things you can try to minimize the effects of price movements. To find out what you can do to minimize the effects of market volatility on your investment portfolio, reach out to a professional financial advisor who can advise you on the same.

Find out more about volatility and how to invest in a volatile market.

What is market volatility?

Market volatility is the abrupt change in prices. It can be measured by the standard deviation. It can also be measured by the VIX (Cboe Volatility Index), also known as the fear index, which uses investors’ expectations to gauge price movements. For the better part of it, you may not see any volatility. On most days, benchmark indexes like the S&P 500 gain or lose less than 1%.

Moreover, expecting 15% volatility from average returns is typical for an average investor in a year. However, sometimes, the market may move up or down sharply and raise an alarm. This can be due to a pandemic, as it was when Covid-19 hit the world. It could also be because of armed conflict, as it is now with the ongoing Ukraine and Russia war. The day Russia invaded Ukraine, the S&P 500 Index dropped 2.4%. This was the lowest in the previous nine months and plummeted U.S. stocks to their lowest level since May 2021. Having said that, it is normal for the market to go down by 30% every five years.

Market volatility is different from risk, as the latter denotes the possibility of losing your money when invested in the market. However, market volatility is directly linked to market risk. When volatility rises, so does risk.

What causes market volatility?

Market volatility can be created due to a number of factors, such as:

1. Political factors

Any political event can affect stock prices and dictate investor sentiment. Trade agreements, changing governments, political speeches, new policies, and others can lead to increased market volatility.

2. Industry factors

A specific government ruling that affects a particular industry can cause volatility. A shortage of a specific item, such as fuel, can lead to a price rise and uncertainty in the market. The current soaring fuel prices are an excellent example of how industry factors impact market volatility.

3. Economic factors

If the economy is doing well, people have jobs, inflation is controlled, and businesses are performing well, the market volatility reduces. However, if the economy is not in a good state, inflation is high, and unemployment is soaring, its reflection can also be seen in the stock market.

4. Business factors

Company-level factors like a data breach, product recall, negative performance, etc., can create volatility in the stock market. This can seem more pronounced in the case of small businesses like small-cap companies.

How to take advantage of market volatility

Market volatility is inevitable. So, instead of fearing it and selling your stocks in a state of panic, adopting a sound investment strategy can be a better idea. Here are some things you can do to beat market volatility:

1. Diversify your investment portfolio

Diversification can be one of the most helpful strategies to beat investment risk and lower market volatility. Putting your money across different asset classes and industries offers immunity against sharp downturns in a particular class or sector. While equity or stocks are the most obvious choice for investors and have proven their mettle as far as long-term gains are concerned, diversification by adding bonds, commodities, real estate, currencies, and cash can be helpful when stock prices go haywire. Some of these asset classes, like commodities, real estate, etc., do not necessarily move with the market. Compared to stocks, they are less susceptible to stock market fluctuations and are often inversely related or non-correlated to the market. So, putting a chunk of your money in these asset classes can help you minimize your losses in a downturn and stay on course for your journey towards your goals.

Dividend-paying stocks can be another investment you can consider in a volatile market. Dividend-paying stocks of stable companies can deliver above-average returns and stabilize your investment portfolio. You can also consider investing in mutual funds or exchange-traded funds (ETFs). ETFs invest in stocks, commodities, bonds, futures contracts, currencies, and others and offer a good basket of securities for you to explore. They can be great diversifiers and help you even when the market is volatile. Mutual funds can also be an excellent option as they invest in several stocks and other securities. Moreover, since they are professionally managed, they can be the best investments for volatile market conditions; the manager takes critical decisions, while you can sit back and relax, waiting for the market to bounce back.

2. Invest in large-cap companies

Market capitalization refers to the total outstanding shares of a company. There are three types of companies based on market capitalization – large-cap companies, mid-cap companies, and small-cap companies. Large-cap companies are the big players. These are well-established and have been around for some time. As a result, they are usually the least affected when the market falls. Mid-cap companies are second in line and are relatively newer and less established. So, when the market falls, these companies can suffer losses. However, they are still comparatively stable. Small-cap companies are the riskiest of the lot. These are new businesses that may not have been around for long. When it comes to returns, small-cap companies can offer high risk and high returns. Mid-cap companies fall in the moderate risk and moderate returns section, and large-cap companies may offer the lowest returns and the least risk out of the three. This is why large-cap stocks make for the best investments in a volatile market. Instead of selling your stocks in a panic, you can consider switching to mid or large-cap options to lower risk. In most cases, big corporations and well-established businesses are able to withstand extreme market conditions. So, by investing in them, you are able to take a better position and outride volatility. Once the market has been corrected, you switch back to mid or small-cap funds and potentially earn higher returns.

3. Set stop-loss orders

A stop-loss order allows you to buy or sell a stock when it reaches a specific price. You can set a stop-loss order with your broker. The broker will automatically process your order and sell the stock when the stock price falls to the set limit. For instance, if you set the stop-loss order at 5% of the stock price, the order will be executed when the stock’s price falls to less than 5% of its current price. One of the most significant advantages of a stop-loss order is that you do not have to time the market and look at prices every day. You can simply set a stop-loss order based on the profits or losses you have earned through the stock so far. A stop-loss order is not placed on the price you bought the stock for but on the current price. So, you have scope to earn a profit even if prices fall. Once the price reaches the set limit, the order will be placed directly, irrespective of where you are or what you are doing. This ensures that you do not suffer losses beyond a certain point.

Moreover, setting a stop-loss order is very easy, convenient, and in most cases, free, making it ideal for new investors. Another benefit of placing a stop-loss order is that your decisions are free from any emotional bias. Sometimes an unwavering faith in a company or being busy and procrastinating to check stock prices can adversely impact your ability to make timely decisions and ultimately harm your portfolio.

However, when creating a stop-loss order, make sure you understand the taxability of the stocks you sell. Selling a stock will trigger the tax, which may put you in a higher tax bracket. So, set orders after carefully understanding the pros and cons of your decisions. In addition to this, a stop-loss order cannot be placed for all types of stocks. For instance, OTC Bulletin Board stocks or penny stocks do not accept stop-loss orders. Also, no matter how easy and convenient they are, they do require some effort on the part of the investor to set the correct percentage for the order. So, even new investors would need some amount of market knowledge to use the order effectively.

4. Use the buy and hold strategy

The buy and hold investment strategy focuses on the investment approach rather than spending time on selecting the best investments for volatile market conditions. It states that a long-term investment in stocks, ETFs, mutual funds, etc., can offer better returns and immunization from short-term price movements. Investors and financial experts, including famous personalities like Warren Buffett, are big cheerleaders of the strategy and recommend it as a way to deal with market volatility. The buy and hold strategy offers some key advantages. Firstly, this is a passive investment strategy that removes the need to time the market and take active decisions with regard to buying and selling stocks. Secondly, the method can reduce tax liabilities by deferring capital gains tax for the future. The long-term capital gains tax rate is also relatively low and helps maximize profits upon redemption. Holding a stock for a long time also offers other benefits. Shareholders have ownership of the company. This allows them to take part in critical decisions like mergers, the election of directors, etc.

The long-term approach to investing can be particularly great if you do not have the time and experience to time the market yourself. In this case, the passive strategy lets your money ride out short-term fluctuations and ultimately delivers stable returns. However, if you are experienced in investing and can time the market yourself, you can opt for other options, such as switching to large-cap funds, setting stop-loss orders, etc. You can also buy stocks at a low price when the prices are down. A market downturn is a great time to pick stocks at discounted prices. You can buy stocks for half their original average prices. If you are an active investor, you can use this opportunity to fill your stock portfolio with some good options that are likely to bounce back when the market corrects itself and make an enormous profit on your purchases.

To conclude

Bonds, U.S Treasury Bills, gold, etc., can also be some examples of the best investments in a volatile marketNot only do they help diversify during market volatility, but they also provide stable returns across market cycles. In addition to this, it may be advised to maintain an emergency fund to ensure that you have a safety blanket when the market falls. Emergency funds are often in debt funds like liquid funds or cash like in bank accounts, so your money will be unaffected by the market forces.

These four strategies can be helpful in dealing with market volatility. However, if you need more assistance on how to invest in a volatile market, use the free advisor match service to engage with a professional financial advisor, who can advise you on how to navigate market volatility. Based on your requirements, the service matches you with 1-3 advisors suited to meet your financial needs and goals.

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The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice.
A professional financial advisor should be consulted prior to making any investment decisions. Each person's financial situation is unique, and your advisor would be able to provide you with the financial information and advice related to your financial situation.