While many investors may be fooled by the market’s low volatility, knowledgeable investors understand that the stock market rarely stays in the same mood for long periods, so it’s normal to expect more unpredictable trading sessions shortly. As a result, traders must have a plan in place for what they will do if the market becomes difficult to traverse once more.
What Is Volatility and How Does It Affect You?
Volatility is a measure of a security’s or market index’s return dispersion. Volatility, to put it another way, is the size of an asset’s price swings around its mean price. Volatility can be measured and calculated in a variety of methods, with the most basic and widely used historical performance indicator being a histogram.
Investors constantly consider volatility when making investments since volatile assets are generally riskier than assets with less departure from the mean. This concept influences a large number of investor portfolios. Younger folks are more likely to have more aggressive investments that can absorb volatility over a lengthy period. Investors approaching or in retirement who choose more predictable, less deviating assets have the opposite problem.
Hedging entails taking short positions in opposition to your long positions. Assume you own 100 shares of Qualcomm stock and believe that the market is due for a correction. You may short sell 100 shares of high beta, overvalued stock that, in the event of a market correction, would fall faster than the broader market. Then, if you believe the market will recover, you can cover your short position. You may have lost money on the Qualcomm trade, but you profited on the short trade.
When traders have a high-risk appetite, they don’t hold many fixed-income products, but when the market becomes untrustworthy and they need safe havens for their money that won’t react negatively to overall market movements, they may turn to the bond market. When the market is falling, bonds, bond ETFs, and treasuries all act as safe-havens. It not only reduces volatility but also helps the trader to make money.
One of the simplest and most significant aspects of volatility mitigation is diversification. Diversification, like the old “don’t put all your eggs in one basket,” protects your portfolio by spreading out the risk.
It’s difficult to time the market, and it’s even more difficult with individual securities. A combination of asset types and investment vehicles in a diversified portfolio helps to limit becoming overexposed to any one sector or commodity. These can be spread out even more by combining domestic and overseas interests.
Sitting out is the simplest approach to limiting portfolio volatility. You can entirely protect yourself against short-term market swings by selling your positions and increasing your cash allocation. Long-term cash holdings aren’t recommended because money is subject to inflation, but for traders who feel the market will soon stabilize, cash is a convenient way to limit losses.
Long-term investors may need to react to market volatility. Market fluctuations do not affect your portfolio’s long-term goal, so you don’t need to make any changes to your holdings. Stay the course and remember that the market has always recovered.