How to Invest in Volatile Markets
Price waves have widened significantly and quickly since September. On 18 separate days last month, the Dow Jones swung by at least 200 points. In one week, it moved more than 400 points a day for four consecutive days. And, on October 4, it abruptly turned from a decline and jumped 400 points in less than an hour.
Volatility within the stock market doesn’t measure the direction of the price change, but rather their dispersion. Remember calculus deviations, where the differences are always squared so that the negative and positive differences are combined into one quantity. It all reflects the full measure of a pendulum swing of any particular stock or sector.
Price volatility is important for two overarching reasons:
First, volatility allows investors to buy assets cheaply and then sell when they are overpriced. “Buy low, sell high.”
Second, since the market ultimately reflects fickle investors and consumers, price volatility creates a fair amount of uncertainty. Final portfolios values vary daily, and averages fluctuate. Entire fields are dedicated to developing models to forecast the volatility of financial returns, but ultimately, no model or prediction is foolproof or definite.
With this in mind, Reuters lays out four survival strategies for investors coping with volatility:
1. Pay Attention
The old strategy of simply buying and then forgetting about your stock is a lot harder to maintain when flashing price-fluctuation headlines frequently catch your attention. Paying attention doesn’t require day trading, but it allows you to be prepared to sell losing stocks or make short gains on stocks with temporary potential.
2. Buy Strategically
“No one is really that good at reading the crystal ball,” Diane Rolfsmeyer, a certified financial planner from Lincoln, Nebraska points out. Accordingly, a survival strategy known as “dollar cost averaging” can lower the risk for new investors. Rather than investing your money all at once and increasing the chance that you bought on a bad day, divide the money and buy gradually over a few weeks or months.
For example, if you have $2,000 to invest, split up your decision into monthly buys of $500. You might buy shares worth $10 the first month, $8 the next, $5 the next, $8 the next, and $10 the last. The average cost of your shares would be $8.20, rather than purchasing all your stocks the first month and having the average cost $10.00.
3. Play It Safe
Rather than living on the edge and trying to ride the volatility, you could insure against it. As Jason Ware, an analyst with Albion Financial Group says, “volatility is usually reflective of fear, so safe assets like gold and Treasury bonds will continue to do well when volatility spikes.”
4. Cherry-Pick Your Stocks
During 2009 and 2010, it was easy to devote attention to a particular sector of the economy simply because many of the companies associated with that sector maintained the same price trends and volatility fluctuations. Now, however, recent volatility is resulting in individual stocks, of the same sector, going their own way—partly because the big sector schemes have played themselves out, according to Ware. Now, more than ever, it’s important to weed through the trends and look for quality products and sustainable brands that reflect thriving and adaptable companies.
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