Emotions play a vital role in the decision making process. However, when it comes to making an investment decision in a volatile market, choosing to follow emotions too closely might take the investments in the wrong direction. In the opinion of Kavan Choksi, investors should either opt for a non-directional or probability-based trading approach for the purpose of protecting their assets from potential losses. The investors might even be able to profit from rising volatility using certain strategies.
Kavan Choksi provides an insight into investment approach for volatile markets
As an investor, one must have a good understanding of the difference between volatility and risk prior to deciding on a trading method to be followed. Volatility in the financial markets is considered to be the quantification of the magnitude and speed of the price swings of an asset. Any kind of asset that sees the market price over time would have a certain level of volatility. The greater the volatility in the market, the more frequent would those swings be. On the other hand, risk implies to the possibility of losing some or all of an investment. There are multiple types of risks that may lead to a potential loss, which includes market risks.
Market risk goes up as the volatility of the market increases. There can be a significant increase in the volume of trades during these periods in response, along with a corresponding reducing in the holding periods of positions. Hypersensitivity to news is commonly reflected in prices during situations of extreme volatility as the market is prone to overreacting. As a result, increased volatility might correspond to larger and more frequent downswings, presenting a market risk for investors. Fortunately, volatility can be hedged to a certain extent. Moreover, there are ways to make direct profits from increased volatility.
Hedging against losses as the markets turn volatile is probably among the most important objectives of long term investors. Selling shares or setting stop-loss orders to sell off shares automatically as the prices fall by a certain amount are easy ways to achieve this objective. But doing so can also create taxable events and removes the investments from one’s portfolio. As a result, this usually is not the best course of action for a typical buy-and-hold investor. Rather, they can opt to purchase protective put options on a broader index such as the S&P 500 or simply on the stocks they own. Having a put option provides the holder with the right to sell off underlying shares at a set price on or before the contract expires. As per Kavan Choksi, investors who want to take a directional bet on volatility itself may trade ETNs or ETFs that track a volatility index like the Volatility Index (VIX).
Investors may also consider purchasing options contracts in order to profit from increasing volatility in the market. Options prices are linked closely to volatility and shall increase with it. As volatile markets can lead to swings downwards and upwards, both straddle and strangle would be good strategies.
