Abrupt changes in stock price volatility levels seem to be suggesting that a new bear market may have emerged in what some analysts are now calling an “economic pandemic.”
However, the reality is that investors shouldn’t feel paralyzed by the deep concerns that typically come as the result of negative headlines generated by the popular financial news media outlets.
In fact, these are the types of market environments that will often result in some of the strongest gains for investors willing to focus on strategic alternatives devoted to the asset classes that are most likely to benefit from a new paradigm as shifts occur in the broader market.
For investors, it’s often true that the most difficult parts of the process include the identification of trend-bottoming signals or the task of selecting which asset classes are most likely to outperform in the periods following an increase in stock market volatility.
Of course, we should also add the fact that an “everything rally” has complicated matters by distorting valuations in several different asset classes.
From a strategic standpoint, investors must understand volatility for what it actually is. In most cases, stock volatility is generated by negative news events because decisions based on fear tend to be accompanied by panic reactions that are much more significant than those based on optimism. Fortunately, downside breakout strategies will often work well for technical analysis traders during these types of negative market environments.
However, whenever the long-term trend is dominantly bullish (as has been the case in the S&P 500 for most of the last decade), upside reversals can materialize without much warning.
This is simply the nature of the beast but the unfortunate piece of the puzzle is that unexpected reversals can quickly lead to losses for anyone holding short positions. For these reasons, leveraged trades should be viewed as unnecessary and dangerous during certain market scenarios.
After all, market volatility itself is always going to be the most significant factor driving profits and losses in any trading strategy. Price movements that deviate significantly from the historical averages suggest that shifts in the paradigm have become apparent and this is something that’s true for all of the major asset classes.
In my own trading, keeping things simple has been the approach that has consistently produced the best results.
For example, placing trade entries outside of major support or resistance levels that are clearly defined will give markets the additional space that’s needed in order to clear out weaker positions. Forceful breakouts that occur during periods of rising volatility can then be managed in an active manner using a trailing stop-loss order to secure profits once they begin to materialize.
Emotional reactions can be especially detrimental during market periods that are characterized by rapid price change.
However, an objective approach to positioning that has been validated by historical back testing can help traders avoid many of the losses that typically accompany violent price swings in the market.
For these reasons, volatile price environments should be viewed in light of their potential positives (rather than their negatives) and navigated in ways that maximize gains while actively limiting the potential for unexpected losses.
Richard Cox is a personal investor with more than two decades of experience in the financial markets. He is a syndicated writer, with works appearing on CNBC, NASDAQ, Economy Watch, Motley Fool, and Wired Magazine.
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