Market fluctuations are quite common and it can continue to persist until there is a meaningful consensus by investors about the future trend or performance.
Market fluctuations are also known as volatility in the markets. It is a term used when the prices of stocks rise and fall a lot without any indication of a trend.
Statistically, it is measured by standard deviation which denotes the quantum of variation that can be expected in the near future.
Volatility occurs when there is higher uncertainty about the future and because of that traders buy and sell frantically to make quick profits or to protect their capital by reducing losses. Market fluctuations are quite common and it can continue to persist until there is a meaningful consensus by investors about the future trend or performance.
Usually, volatility is emotionally captivating for most people and can tempt you to make irrational decisions in the heat of the moment.
To avoid becoming a victim of emotional turmoil, you can do the following:
Understand that every successful investment has a degree of uncertainty – If you accept this, you will be able to take a backseat, take a deep breath and look at it more objectively. As a matter of fact, most multi-bagger stocks have to go through times where everybody will doubt its potential to appreciate beyond a particular point. But in hindsight, such companies have surpassed that phase and delivered very high returns for investors.
You can stomach volatility only if you accept the reality that uncertainty is part of the game and to earn big, you’ll have to think big!
Think long-term – Instead of thinking what the price of a stock/instrument will be in a few hours or by next morning, project its value a year from now and then contemplate if it’s worth staying invested until then. Keep in mind that volatility is a temporary phenomenon and lasts until there is no clear consensus. So, if you can be patient and ignore market fluctuations, then you can easily deal with volatility. Patience is a virtue in everything including trading/investing. Sometimes, it is best not to try and time the market because in such times it may not work and you may get whipsawed on both sides (Long and short).
Hedge your risks – You can do this in several ways but the most common way of hedging your risk is by diversification. Basically, spread your eggs in different baskets because it helps to deal with the downside. For example, if you have invested your capital in 10 different stocks in equal proportion then even if the volatile stock goes down by 20 percent, the net effect on your total returns will be only two percent (20 percent of 1/10th of your total capital in one stock
Make sure you diversify in stocks which are from different sectors to avoid high correlation. You can also hedge your risk by using options. One way of protecting your downside is by buying put options as it will ensure that your losses will not exceed a certain limit.
Avoid leverage with directional trades – Leverage is a double-edged sword. If you use it at the right time, your returns will be multi-fold. If you use it during a period of heavy uncertainty, then you may unnecessarily burn your fingers because minor fluctuations will have a major impact on your percentage P&L of your account. For instance, let’s say you’re leveraged 10 times with Nifty futures and you’re trying to buy and sell Nifty 50 to make a few points on each trade. But a 1 percent movement will have a 10 percent impact on your capital. Considering that 1 percent is easily possible in times of chaos, it is best to avoid timing the market with leverage.
The random price movements can emotionally overwhelm you if you’re caught on the wrong side with a large position.
Rupee cost averaging – If you are not leveraged, each dip in the stock price is an opportunity to buy if you believe that in the future the price is going to be higher. Rupee cost averaging is a term used for buying incrementally each time the value falls. Traditional wisdom does not advocate this, but if you are not leveraged and you are buying in the lower band of a well-defined range, it helps you accumulate additional shares, reduce the average cost and also overall risk by narrowing your long-term stop loss. To be able to do this, you’ll need to infuse additional capital.
Options strategies – If you are a trader who understands the type and nature of volatility in the market, you could take advantage of the situation and sell options if you believe that volatility will continue in the near-term future. It gives you an opportunity to earn money be pocketing the options premium that is paid buy options buyers. Some popular strategies that you can explore are; Short Strange, Short Straddle, Iron Condor, Reverse Iron Condor, Covered Call, etc. These strategies make the most money if the market “does not move much” in the stipulated time. One can expect to make 2-6 percent within a month if executed properly.
Whatever you choose to do, keep the current situation in mind because each one is different from the other. Markets are dynamic and if you want to be successful, your approach has to be too.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)
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