Stock market goes through different phases ranging from complete euphoria to utter demise. The markets can go from a bull market to a bear market and vice versa or can stay in limbo for months or even years! One such phase which the stock market undergoes from time to time is the phase of high volatility. The high volatility phase of the stock market can lead to wild swings when sentiments swing from bullish to bearish & vice versa within minutes. But the question which many retailers wonder is – What should a trader do during high volatility?
What causes high volatility?
The biggest (and probably the only reason) for stock market volatility is uncertainty! Stock market always becomes volatile whenever there are big global events such as war, political changes, terrorist attacks, natural calamities, etc. The reason for the increase in volatility is that such events increase uncertainty amongst investors and traders. If there is one thing which the stock market passionately hates, its uncertainty! Lack of a clear future vision causes big funds to buy or sell stocks leading to panic in the stock market thereby increasing the volatility.
How to know that the volatility is high?
The first step is to figure out if the market volatility is high or low. Market volatility in the Indian stock market is measured using an index called Nifty VIX (sometimes also known as India VIX). VIX measured the extent of the movement of the stocks. A VIX value of under 20 is considered to be “normal” in terms of the market volatility. On the other hand, a VIX value of over 20 means that the stock market is entering a high volatility territory.
A trader needs to become cautious about the market when the VIX value crosses over 20-25 because that is a clear indication of high volatility.
What should traders do about it?
Simply put, high volatility is a bad time for stock trading. There are multiple reasons for a stock trader to minimize (or completely stop) trading activities during the high volatility phase of the stock market.
-
Breakouts have a higher probability to fail
Many stocks which give a breakout (or are on the verge of a breakout) can fail during high volatility. Technical analysis becomes less effective during volatility because the sentiments are on the rise. Stocks which give a clear breakout can suddenly make a U-turn towards the stop-loss.
-
Stop-losses will easily trigger
Stop-loss is an extremely essential tool which every trader should follow religiously. However, during the times of high volatility these stop-losses become very easy to trigger and can lead to unnecessary losses. Remember, a stop-loss is still a loss! Even if you are properly following the stop-loss, regularly triggering the stop-loss leads to erosion of your capital. This doesn’t mean that the trader should simply stop using a stop-loss! The trader should simply reduce their trading positions to avoid triggering stop-losses easily. To learn about a profitable trading system which professional traders use, visit this article!
-
There will be no clear trend to trade
Volatile times are often accompanied by a choppy market. The market participants are unclear about the future of the stock market. This causes the stock market to simply trade between a range. The size of the range depends on the amount of volatility i.e. the range can be huge during extreme volatility. A professional trader always waits for a clear trend to take up fresh positions. Trading a choppy market is an easy way to lose your money in the market.
-
High dependence of luck
Since the market sentiments are on the rise, most successful trades during high volatility are the result of luck rather than stock analysis. Also, traders who do not have the habit of following stop-loss can surprisingly perform better than a disciplined trader who consistently follows stop-loss. However, a habit of not following stop-loss can get a stock trader financially killed in the stock market in the long run! Winning trades during high volatility are often simply a result of luck and not skill.
High volatility in the market is often short-lived and leads to a clear trend. This is when the stock trader should enter fresh positions because the chances of making a profit increases significantly!
Conclusion
Stock traders should minimize (or completely avoid) their trading positions during times of high volatility. A smart trader should wait for a clear trend to resume before entering fresh trading positions. However, volatility provides an amazing opportunity for a long term investor to accumulate stocks. The rise in panic causes many stocks to be available at a cheaper price. The final decision to buy or sell stocks depends entirely upon the reader.
If you liked this article, share & subscribe to this website! Follow us on Twitter!
DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
- 4 Types of Stocks which Long-Term Investors should avoid! - May 6, 2023
- Why do some companies trade at a very low P/E multiple? - November 1, 2022
- Why most investors end up buying stocks at the wrong time? - October 26, 2022
