How should you handle a volatile market? Well, before I dive into that, I think I should first answer the question: What is a volatile market? A volatile market is defined by Investwords.com as “Unpredictable and vigorous changes in price within the stock market.” I think the last few weeks or even months have proved that we are in a volatile market. This is a big change from the 12 months or so prior to August, where the market was trading in a fairly tight range without a lot of big daily changes. Does volatility always mean the market is falling? The answer to that is no, volatility goes both ways.
So what causes volatility? Many things cause market volatility, but there are some key drivers. The most important is human emotion and reaction. Even disciplined investors get scared and want to sell when the market is headed down. A great example of this was the huge one day drop in August, where everything was in a free-fall, and there was no safe haven. Another cause is economic data. Poor economic data can lead people to believe that the market is going to decline, and conversely, strong economic data can lead people to believe the market will improve. Another driver of volatility is earnings reports from publicly traded companies. Strong sales and earnings should drive the value of publicly traded companies up, while poor reports drive the value down. Analysts take all this data and report on what a company’s stock value should be based on their profitability and future projections are. The last key driver of volatility is government policy. Policies set by the government can either help or hinder a business in their pursuit of profit. Changes in these policies that affect the business environment will affect the valuation of companies and their future earnings.
How an investor reacts to volatility should come down to 1 thing: What type of investor are you? If you are a long-term investor, you tend to fear volatile markets, but should actually love them. Volatility presents buying opportunities for you, and you should take advantage of them. If you are fully invested, and don't have cash on the sidelines, reinvesting your dividends is a way to buy more shares of stock at low prices.
If you are retired, you most likely hate volatile markets, and rightly so. People depending on their portfolio to last through their retirement see any decline in value as a threat to outliving their money. For this reason, investing in a more conservative, income-producing portfolio in retirement is prudent. These types of portfolios won't typically realize the full gains in the market when it is rising, but conversely, won't see the full declines when the market is falling. This is especially true if you need the principal from your portfolio to live on. Make sure that you are invested in a low volatility portfolio that focuses on capital preservation
If you are a day trader or active trader, you should look at volatile markets as the best way to make profits. Volatility in stocks presents the most opportunities to realize profits on short-term trades. This is a very risky strategy, and not one we recommend, but if you use it, there should be plenty of opportunity right now!
For long-term investor, the best thing to do is wait it out. Over many years, stock market has proved it will find its way to the right value. It may over-react on its way to get there, but these over-reactions usually sort themselves out in a timely manner.
If you have the stomach for it, and this is in no way a recommendation, there are funds that profit from volatility. The first is the VIX, the S&P 500 Volatility Index. Proshares offers a VIX Short-Term Futures ETF that trades under the symbol VIXY. There are also double VIX funds like UVXY, and several others, all of which should be traded with caution. The fund UVXY was down over 74% in the last twelve months at the time I was writing this.
If you have any questions about any of these strategies, or would just like us to look at your portfolio and make sure you are invested properly, give us a call at the office at 904.685.1505.