Five trading strategies in a highly volatile market

Volatile markets require certain trading strategies. Managing risk by setting stop losses or trading options are examples. Here are five of them.

Aug 07, 2020 08:08 IST India Infoline News Service

The nature of markets is to be volatile. World events, a pandemic such as the coronavirus, conflict can all make a difference to the market. Before that, it helps to understand what volatility is. Market volatility is the sharp movement of a security’s price upwards or downwards in a short time. 
 
The strategies you use in a low volatility market situation are not necessarily what you use in times of high volatility. Here are five such trading strategies that you can use in a highly volatile market:
  1. Consider stop loss: Stop loss is an important aspect of your trading plan. It is aimed at limiting your loss on the position of a security which moves in an unfavourable direction. Placing a stop loss helps you check erosion of capital and protects you from the risks that come with adverse movement of prices. In the case of a volatile market, when swing in prices are higher than usual, you could place a broader stop loss than you would when the markets are not volatile. This helps you from getting stopped out because of more than usual fluctuations of prices intraday, while trying to ensure your exposure to risk stays the same. In a volatile market, your stop order can be executed quite far from the stop price. Stop loss ensures discipline in your trade.
  2. Try trading options: In times of a highly volatile market, you may wish to consider trading options. One well known option trading strategy is called the Straddle, wherein you buy a call and out option at the same strike price and date of expiration. This option strategy helps traders to benefit from the direction of change in underlying price.
  3. Look for breakouts: An oft-used trading strategy is to buy the breakout. With the help of this strategy, traders track stocks that are trading within a support-resistance range that can be identified. Till such a time as the stock stays in this range, the trade doesn’t take any action but if there is a breakout of price towards the upside, then the trader seeks to buy that stock because the breakout marks the start of a new uptrend for the stock. When there’s no volatility, the stock may breakout towards the upside but lose momentum and fall back under the breakout level or drift sideways. In a volatile market situation, prices move quickly and the breakout upside may be followed by a movement to much higher prices. This is why breakouts are traded in volatile situations. On the flip side, if the breakout doesn’t sustain, the reversal can be faster and steeper than during a non-volatile situation. Because of this, a trader interested in buying the breakout should place a stop loss order to cut or limit losses.
  4. Look at stocks that are trending in line with the market: Keep an eye on stocks that are trending in the direction of the market so you can benefit faster than normal. Stocks that are trending will see the rate of trend go up in a volatile market. The risk is high but the gains are also high. You would however get in before the price acceleration happens not after the price increases.
  5. Take profits frequently: When markets are volatile, it helps to take out profits from time to time as an overnight high risk can erode your profits in a jiffy. Taking out profits will help you have some much-need liquidity in a volatile market situation.
 
Other points to ponder
 
Managing risk is a key element of trading in a volatile market. A way to manage risks is to buy or sell stocks incrementally, as it helps cut down any risks when there are sudden movements. It also helps to take a long-term view to your investments. There are traders who ignore volatility over the short-term, while others resort to panic selling at volatile times. There are traders who will look to “buy the dip” as it is called. Different traders take different approaches.
 
In conclusion
 
Volatility is an important aspect of the market and many traders may find it comfortable to sit out and minimise risks. Others would like to explore strategies to make the most of the volatility. Traders would need to define their individual objectives and assess risks. Reviewing risks and reducing position size or changing stop loss placements wider than normal are all steps you can take. Whether you are a beginner or an expert, it helps to pay close heed to volatility and evolve your strategies.

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