Volatility is a regular feature of the market and offers opportunities for traders. But it also poses increased risks to your capital; therefore it’s crucial that traders have a plan in place when volatility arises.
Effective risk management strategies, continuous learning and monitoring market trends are crucial in trading volatile markets while mitigating risks.
1. Diversify Your Portfolio
Diversifying your portfolio when trading volatile markets is crucial. Doing this means spreading risk across different assets, sectors and regions so as to limit your losses in case one area experiences a drawdown while taking advantage of opportunities elsewhere.
As an example, you might invest in US small and large caps stocks, international stocks, investment-grade bonds, commodities or even hedging strategies using correlation pairs or volatility indicators like Bollinger Bands to spot overbought and oversold conditions.
Target-date funds offer another solution for managing asset allocation and diversification on your behalf, though these tend to be more costly than basic ETFs. Target-date funds may be ideal if you lack time or desire to manage their own investments; however, any effective investment strategy must start with creating an investing plan tailored specifically towards your goals and financial situation as a foundation.
2. Stay Informed
When market volatility spikes, it can be tempting to opt out altogether – however this could prevent you from capitalising on volatile conditions and profiting from them.
Staying informed is one of the best ways to navigate volatile markets, from keeping up-to-date on economic events and news to understanding what drives price movements.
Under volatile market conditions, you should carefully consider both the size and risk-reward ratios of your trades. Some traders may opt to trade smaller positions (commit less capital per trade) with wider stop-loss limits than they might under less volatile circumstances.
Some traders opt for non-directional strategies like options or spreads in order to take advantage of market volatility without trying to anticipate price movements. A straddle strategy involves buying and selling options with similar strike prices and expiry dates to speculate on movement without pinpointing a particular direction.
3. Use Stop Loss Orders
Volatile markets present traders with the possibility of sudden price reversals that can lead to larger losses than would occur otherwise, so using a stop loss order ensures any potential losses are covered before they occur.
Traders can set up stop loss orders by identifying areas of support or resistance on a chart. This occurs when prices have failed to breach or surpass an important point that signals potential reversal – typically using tools such as Fibonacci retracements on charts to mark these levels.
As well as setting stop loss orders, traders can also limit their risk exposure by trading smaller time-frames. This enables them to reduce position sizes and increase chances of profitable trades while simultaneously controlling leverage exposure.
4. Stay Disciplined
Trading in volatile markets requires disciplined decisions and overtrading, to prevent emotional decisions and overtrading. Staying focused on long-term investment goals while understanding that short-term market setbacks typically result in recovery periods is essential to successful investing.
At the same time, it’s essential to distinguish between volatility and risk. Volatility cannot be predicted or managed directly; risk management however can be managed efficiently depending on how much capital traders are willing and able to risk with.
Some traders take a more conservative approach during volatile markets by trading smaller trades with wider stop loss orders than they might in calmer conditions, in order to limit losses in case of sudden market reversals. Others may follow news articles or follow events such as economic data releases or political developments which might spur volatility; and opting for longer time frames helps focus on long-term goals rather than being distracted by short-term price fluctuations.