Keeping It Together during volatile trading sessions is an extremely valuable skill. Recent events in 2020 have highlighted the frailties of the financial system that most everybody banks on for their stability. COVID-19 a.k.a. the Coronavirus has brought about tremendous economic upheaval, the likes of which the world economy has rarely experienced. The 1929 Wall Street crash, and the Great Depression which followed; the oil price shocks of the 1970s, and the collapse of Lehman Bros and the ensuing recession of 2008 represent a handful of the financial cataclysms of this magnitude.
The Dow Jones Industrial Average, a powerful symbol of financial success wavered in the face of extreme volatility as a shutdown slammed the brakes on the global economy. Wave after wave – an unrelenting barrage – has characterised the financial markets since March 2020, with more to come. The uncertainty of our time has not deterred savvy traders and investors from their craft. Indeed, it is this selfsame volatility that presents a myriad of opportunities for traders and investors to seize upon. Market corrections are an altogether common occurrence; these price adjustments rebalance the scales, allowing for greater value propositions. Buying on the dip is one of many ways that intelligent investors are trading online.
In this in-depth expose, entrepreneurs are introduced to several important concepts, tactics, and strategies necessary for trading during volatile times. It should be stated upfront that a global pandemic presents a unique set of challenges to traders. Natural disasters and pandemics typically arrive out of the blue – little or no preparation is possible. When they hit, it’s like taking a sledgehammer to your financial portfolio. The initial ‘shock and awe’ is followed by consolidation, reflection, and strategizing. Several intractable realities have transpired; holding onto cash is not a viable proposition – financial instruments such as stocks, bonds, commodities, indices, and crypto typically have a much better return over the long run. Having said that, the focus shifts to effective strategies for trading during volatility.
What is volatility and how do you identify it?
Volatility is perhaps best defined as extremely unpredictable behavior characterized by rapid cycling, sharp price appreciation and depreciation, and an imbalance in market dynamics. This set of circumstances prevents the matching of buy and sell orders, resulting in disequilibrium over the short term. The volatility index (VIX) was created by the Chicago Board Options Exchange (CBOE) to reflect market expectations vis-a-vis 30-day volatility. The VIX is also known as the fear index, and this is used to gauge the degree of price variation over time. By assessing the price swings in a financial instrument such as a stock, it is possible to understand its volatility. The standard deviation from the mean is but one measure used by traders to identify the degree of volatility in the financial markets.
By extrapolating to market level, it is possible to see the attendant risk in a broad-based basket of securities. The VIX is one measure used by traders to determine market volatility. Broadly speaking, when the market is facing widespread selloffs, volatility, fear, and uncertainty are increasing. By contrast, when the market is experiencing bullish behavior (buying of securities, coupled with rising prices and growth), the VIX is declining. These ‘trends’ are especially important as they pertain to trading assets. By taking positions through futures contracts, options traders can go long when the VIX is bullish (low) and go short when the VIX is bearish.
It is extremely important to employ ‘safe’ strategies when trading in volatile markets. There is always the risk of market delays when placing orders for execution. An order executed at the wrong price can mean the difference between profit and loss. Risk can be mitigated by way of limit orders with upper and lower limits placed on the price that a trader is prepared to pay for a financial instrument. There is no guarantee that the order will be executed at that price is, but limit orders are the best way to trade in volatile markets. It is always advisable to monitor the market for a possible slowdown. When this occurs, your orders may execute. Typically, heavy trading volume may prevent orders from being placed at your set price.
Implementing short selling strategies for trading purposes
The majority of people are not engaged in short selling strategies. This in itself is a shortcoming, given that the biggest profits are often earned by way of short sales. However, there is a high degree of risk inherent in short selling, particularly for traders who are not familiar with this concept. Most people trade or invest in the expectation of an asset’s price appreciation over time. ‘Buy low, sell high’ is a mantra that every merchant and every trader has known since time immemorial.
With short selling, that does not necessarily apply, if at all. The rationale behind short selling is simple: Take possession of a financial instrument now with a payback time the future. If the price in the future is less than the price in the present, the difference represents the profit for the trader. If the financial instrument appreciates in price on a short sale, the difference represents the loss for the trade. Incidentally, many brokerages tend to balance their long positions with short positions for a net neutral overall perspective.
Identifying volatile stocks for trading purposes
Various financial filters are available to help identify volatile stocks for trading purposes. These stock screens automatically track volatile stocks and present them in an easy-to-read format. Many traders use such measures on a daily basis. If the average move exceeds 5% per day over a period of time (differential between opening price and closing price), it is regarded as volatile.
Likewise, if trading volumes exceed a certain number, it shows that there is a lot of buying and selling of that particular stock, which increases its volatility. A caveat is in order when trading volatile stocks: There are substantial price swings to consider. Sometimes, the trending behaviour will indicate increasing prices, sometimes the trending behavior will indicate decreasing prices. Various technical indicators can be employed to trade volatile stocks including stochastic oscillators, and Keltner channels.
Cashing in with volatile markets
The beauty of trading during volatile sessions is the returns can be amplified dramatically. There is a reason why people tend to prefer trading over investing, and it is based on a simple reality: When you trade, you are rolling money many times over in a short period of time. It is possible to trade a set figure such as $10,000 and generate substantially more per unit time and money, than the equivalent $10,000 in a long-term investment. To generate money with volatile markets, prices must move.
This is an inescapable reality of all the financial markets, whether it is currencies, commodities, indices, stocks, bonds, or even derivatives trading instruments (CFDs). It is always advisable to pick trending stocks – those where traders are already focused. If the stock’s price has been trending higher, it is possible to buy with the expectation of increased prices. If the stock’s price is starting to reverse, a short seller can buy in the expectation of prices dropping.
All stocks have support and resistance levels. The support level is the foundation and the resistance level is the ceiling. As soon as the stock breaches one of these barriers, it is possible to generate profits by trading. A stock that breaks through its price ceiling is bullish and a stock that breaks through its support level is bearish. By implementing short-term trading strategies, it is possible to take profits rapidly. This approach can be conducted within minutes, as opposed to days, or weeks. The use of stop loss orders is sacrosanct in this regard.
These can be excellent trading strategies for entrepreneurs during volatile times. Implement them with caution, remembering that the fluid nature of markets does not allow you to take your eyes off the prize. Stay focused, stay invested, and stay abreast of the latest developments before you trade stocks online.