Volatility can occur for many reasons. The most recent example: the U.K.'s decision to exit the European Union, which sent the CBOE Volatility Index (VIX) up 15% the day after the vote.
Volatile times provide both opportunities and risks for the more active investor. Here are five tips that can help you potentially capitalize on big price moves.
|1.||Know what type of investor you are.|
For many people, the daily rebalancing act of the market should be of less concern compared with sticking to your long-term investing objectives. If you are a buy-and-hold type of investor, big market swings might be something to keep an eye on, but may not warrant making changes to your strategy.
For more active investors, it may be worth assessing how volatile market swings may impact your strategy and if you want to reposition your portfolio to potentially capitalize on shifts in market trends. If you have extra money on the sidelines, for example, you might decide that you want to use down markets as buying opportunities.
|2.||Look at the big picture.|
It’s not uncommon for investors to get rattled when big market moves happen. Having a long-term view—even if you are a shorter-term trader—can help settle your nerves and assist you in deciding your plan of action. Considering the context of how "Brexit" may impact markets, for example, can help you see the forest from the trees:
- While the exit from the European Union could negatively impact the U.K., there is a tremendous amount of uncertainty as to how significant the impact will be.
- This move could have little impact on the U.S. economy, which is still expanding, albeit slowly.
- While the U.K. does have the fifth largest economy in the world and there are fears that this will begin a domino effect where other countries follow suit, any changes as a result of the Brexit vote will not be taking place overnight.
|3.||Tune up your trading tactics.|
Rather than focusing narrowly on the market action of a few days or weeks, the short-term investor who is looking to tactically trade the market can utilize a number of strategies to navigate volatility. Of course, trading with a short-term time horizon is not for everyone. Indeed, only experienced, knowledgeable investors should consider short-term, market-timing strategies. Even those who are proficient in these areas should consider trading with only a fraction of their total portfolio.
If you are comfortable with this method of investing and are willing to accept the risks, here are some trading tips that could be utilized:
- Consider waiting it out. Even if you are an active investor, waiting out significant market turbulence may be appropriate for your particular strategy. If you are uncomfortable trading in volatile markets, you may want to wait until things calm down so that you can go back to implementing your strategy.
- Trend trade. Just as it can be dangerous to fight the Fed, going against a market trend can be risky, because there may be a valid reason why the trend exists. While it may not always be clear what the predominant trend is in hyper-volatile markets, some investors choose to trade with the trend until there is ample evidence that the trend has reversed. If stocks are moving lower, you might utilize short trades if you are willing to accept the risks of this strategy. If you want to limit some of the risk involved with going short, you might use options strategies like buying puts, a bear call spread, or a bear put spread.
- Target volatility. Big market moves can present an opportunity for some investors. The CBOE Volatility Index (VIX) is a widely used measure of investors’ volatility expectations. You can’t buy or sell the VIX, but you can trade VIX options. For example, you might buy VIX calls if you think volatility will increase, or buy VIX puts if you think volatility will decrease. There are also volatility funds. Additionally, there are more advanced options strategies, like straddles and strangles, that you can execute on any stock that has options, in order to target big price moves.
- Use trading orders. Limit orders, stop orders, and conditional orders are among the various trading orders that you might want to use to more closely manage each trade you make during volatile times. For instance, if you are concerned about a large move to the downside in any of your open positions, one action you can take is to consider tightening your stops on open orders. This strategy involves adjusting stop orders so that they are closer to the current market price (in order to potentially reduce the impact of a large, adverse price swing). If risks dissipate, you can adjust and loosen up your stops. You might also want to place limit orders on all trades, rather than market orders, so that you get filled at a price you want, rather than at a price determined by the ebb and flow of the market. Keep in mind that using these types of orders doesn't guarantee an execution.
- Take profits or harvest losses. Amid shifting market conditions, if you believe that the fundamental picture for a stock has changed, you may want to close some positions and take some profits, or consider harvesting losses. For instance, before the recent correction many stocks were near multiyear highs. If you have stocks or other investments that are still profitable for the year but no longer fit your strategy, you may want to consider taking profits in those investments. Of course, investors need to factor in the additional costs (e.g., brokerage fees) and their own tax situation when making this decision.
- Manage your risk. There are a few ways you can manage your risk in volatile times. For instance, you can use technical tools such as moving averages, as well as key support and resistance levels, to set limit orders at price levels beyond which you would not want to lose any more money. Of course, be sure to give any open trades room to breathe. That is, you may not want to set your limit orders so close to the current market price that your strategy has a lower probability of success. One way to do this is by setting limit orders perhaps a little more than 5% to 10% from the current market price.
|4.||Have a plan.|
As the saying goes, “Failing to plan is planning to fail.” That can be particularly true when it comes to investing. When constructing your investing and trading plan, think about how you may react to big market moves like the ones we are seeing now. Take into account your specific situation—including your investing objectives, risk tolerance, tax implications, and liquidity needs.
When evaluating your plan, here are some questions to ask yourself:
- Do you plan on monitoring your positions throughout the day or on a longer periodic basis?
- Will you take the long view and ride out the storm?
- Do you plan to target new opportunities and reassess your existing holdings?
- What methods (fundamental analysis, technical analysis, etc.) and tools are you going to utilize to evaluate the positions you hold as well as those that you are considering entering into, so that you can make an informed decision?
- If you have a short-term outlook and, based on your risk tolerance, are you going to set conservative or aggressive price targets?
- How much of your portfolio are you going to actively manage, if you are considering doing so?
Answering these questions can help you create a strong plan to manage your exposure to big price moves.
|5.||Know your options.|
It’s easier to plan when you know what resources and tools are at your disposal. Here are several tools that can help you plan to react to volatile markets:
- News, insights, market analysis, and Fidelity Viewpoints.
- Alerts (login required) so that you can stay on top of breaking news.
- Markets and sectors research.
- Options strategies for volatile markets.
- Stock, bond, and commodity ETFs research.
- Fidelity Portfolio Advisory Service® (PAS), if you are a longer-term investor who would like to have Fidelity professionals manage your investments.2
- Asset allocation funds and managed accounts research.
Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.
Investing involves risk, including risk of loss.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917