Most investors know that there are bull runs and downturns in the market. What happens next in a situation where market volatility is high? Making the wrong choices could wipe out all of your previous gains. Using non-directional or probability-based trading strategies, investors can protect their capital from possible losses and benefit from rising volatility with the proper protocols.
Volatility vs. Risk
It is essential to distinguish between risk and volatility before deciding on a trading strategy. Volatility, as used in the financial markets, quantifies the speed and magnitude of price swings of an asset. If the market price of an asset changes over time, it is considered volatile. The higher the volatility, the more frequent and dramatic these movements are. On the other hand, risk is the possibility that an investment will lose everything. Numerous hazards, including market risk (the potential for prices to move against you), can lead to a potential loss.
Hedging Against Volatility
For most long-term investors, protecting against negative losses during volatile markets may be the most crucial factor. Naturally, selling shares or setting stop-loss orders to sell them automatically when prices drop a predetermined amount is one approach to this. However, this can also result in taxable events and remove the investments from an individual’s portfolio. There are often better courses of action for a buy-and-hold investor.
Trading Volatility
Volatility and options prices are firmly related, and volatility will rise along with options prices. Remember that profits gained, including those you use to play on online casino Belgium activities or pass time activities matter and should be in your planned budget. However, buying a straddle or a strangle is common because unpredictable markets can produce price swings that go both ways. These two entail purchasing a call and putting it on the same underlying for the same expiration. Both strategies have the potential to gain value if prices fluctuate significantly.
Non-Directional Investing
Most investors participate in directional investing, which necessitates a steady movement of the markets in a single direction (either up for long positions or down for short positions). Trend followers, market timers, and long or short stock investors use directional investing tactics. Increased volatility can cause a market to move laterally or in no particular direction, which might continually cause stop losses. Years’ worth of gains can be erased in a matter of days.
Equity-Market-Neutral Strategy
The equity-market-neutral strategy is based on the idea that your returns will be less sensitive to market volatility and more directly correlated with the gap between the top and bottom performers than with the market’s overall performance. Purchasing comparatively cheap stocks and selling comparatively expensive stocks that are either in the same industrial sector or seem to be peer companies are the two main components of this strategy. As a result, it makes an equal number of long and short positions in closely connected companies to take advantage of variations in those stock prices.
Merger Arbitrage
The stocks of the two parties involved often react differently when news of a potential merger or acquisition breaks, hoping to take advantage of the shareholders’ emotions. In many cases, the company’s acquired stock rises in anticipation of the takeover, while the acquirer’s shares decrease in value.
A merger arbitrage technique aims to profit from the fact that, because of the possibility that a merger would fail, the merged equities typically trade below the post-merger price. The investor simultaneously purchases stock in the target firm and short stock in the acquiring company, hoping the merger will close.
What Causes Market Volatility?
Generally speaking, increased investor anxiety or uncertainty results in higher market volatility. Both may result from a recession or from natural disasters or geopolitical events.
Summing it Up
To comprehend the risk of a specific stock, one can also turn to fundamental study in addition to hedging. Sometimes, one or more critical pieces of information about a company must be more broadly communicated, or market participants perceive the same differently, even in today’s liquid and relatively efficient markets.
