Investing in volatile markets is never easy. The gyrations of the market can make the best of traders and the coolest of minds panic. You can imagine what happens to small and medium investors. Imagine you had invested in 2007 and saw your portfolio down by 50% in no time. How to deal with volatile markets without forsaking your wealth goals? That is certainly a million dollar question! Remember a basic rule in markets that when you panic in the market, you subsidize the person who does not panic. Here are a few interesting tips for investing in volatile markets. Actually you can also make the volatility work in your favour..
Stick to your long term Financial Plan
Let us remember that all investing begins with our financial plan. You lay down your long term goals and y our medium term goals and your entire investment performance is elegantly designed around this financial plan. What it means is that you need to really have an appetite for handling the volatility in the market. One of the basic rules here is to build in such risk points into your long term plan. For example, you can set a rule that if the P/E valuation of the market as a whole crosses 22 times then you reduce your equity exposure by 10%. Alternatively, if the interest rate spread in India (over the US benchmark) crosses 500 basis points then you shift 20% of your debt portfolio into long term debt. These are the kind of in-built rules that can help you make the best of volatile times.
There is a lot of wisdom in stop losses
Why do we put stop losses? It is meant to protect us in volatile times. As a trader you cannot afford to lose your capital beyond a point. The best way is to trade with stop losses. There are 3 ways to approach the stop loss challenge. Firstly, you can use trading stop losses which can be placed below the support level if you are long and above the resistance level if you are short. Secondly, you can set intuitive stop losses wherein you close the position if the loss crosses a threshold of; say 10%. This is applicable more to medium-term investments and requires close monitoring. Lastly, you can also use trailing stop losses to protect your profits when the price movement is favourable. The purpose of stop loss is to provide you a kind of portfolio insurance.
There is also a lot of wisdom in profit booking
There appears to be a small dichotomy here. We know that you make profits by staying long on your winning trades. Then wouldn’t taking profits compromise on your long term returns. For a trader, profit booking at constant target levels is a must. Otherwise you do not roll your money fast enough. For investors with a medium term perspective, profit booking is again very important as it helps you realize the profits at regular intervals. What about long-term investors, then? In times of heightened volatility, it adds value even for long term investors to take profits off the table. It is better to sit on cash or liquid funds and you can always look at re-entering the stock at a more attractive price point.
Spread your risk; but do it in an organized manner
We have all heard of diversification and the merits of not putting all your eggs in one basket. That is an important factor in ensuring that your long term returns are not compromised in times of volatility. There are two ways to look at it. Firstly, even within equities do not concentrate your portfolio too much on a handful of stories or themes. Try to spread across themes. Include stable dividend yield stocks in your portfolio. At an asset class level, add assets like gold and structures to act as a counter for equity market volatility. This kind of intelligent diversification can go a long way in handling market volatility.
Passive Buy and hold is dead; yes really it is!
In times of volatility you need to manage your portfolio actively. Passive buy and hold is unlikely to work too well. You need to take a call on reducing your exposure to cyclical stocks. You also need to look at ways to restructuring your portfolio and start betting on future stars and exit stocks that have not been performing. You need to reduce the overall risk levels in your portfolio. All this calls for active management. Staying invested passively in such circumstances will not work!
Talk to the experts in times of volatility
Volatility is the time when expert advice is actually required. In bull markets you are likely to make money anyway. Your index fund or your equity mutual fund will anyways give you phenomenal returns. The time you require the help of experts is in times of volatility. That is when experts need to give you a colour of the market, explain to you how to handle the risks, help you hedge your portfolio risk, guide you not to take decisions in a state of panic etc. The onus is on you to talk to your financial advisors and seek advice. Technical expertise and a long experience in markets really helps in these times of volatility.