Investing in a volatile market gives everyone the jitters. Novices, in particular, tend to sell in a panic and then wait for the right time to re-enter the market.
Selling out as stocks fall, however, is a very bad investment strategy.
That’s not how pro investors do it. Investing in a volatile market means buying when other people are selling and you have to make smart investments.
Buying and selling along everyone around you is not how you get ahead.
Stock market volatility explained
The first thing you need to know about the stock market is that it is inherently volatile. It tends to go up, stay steady, go down, and then go up again. This volatility is in fact a never-ending cycle.
Price fluctuations and heavy trading, which are the characteristics of investing in a volatile market, can be caused as a result of a number of factors.
Political developments: Any time there is an unexpected political development, the market tends to take a hit. For instance, when President Trump announced in March that he will be imposing tariffs on Chinese goods to better negotiate the U.S.-China trade imbalance, the market plunged by more than 2% immediately.
Economic developments: If the economy fails to perform to the expectations of the investors, that might impact the market negatively. Inflation rate, monthly jobs reports, consumer spending data, quarterly GDP reports — there are a number of economic factors that can impact market performance in the short run.
Analysts recommendations: The market, and certainly individual shares, can be the subject of a buying or selling spree based on the recommendations made by well-known experts and even ordinary bank analysts.
Other factors that are known to contribute to the volatility of the market the activities of short sellers, day traders, IPOs by large companies, institutional investors, and many more.
How volatility affects trading
One of the characteristics of investing in a volatile market is an unusually high trading volume.
High volume trading might make it difficult to access your online trading account. Heavy trading also means you might find it hard to execute your trades at the price you expect.
Heavy trading invariably leads to delays in execution. There can be a gap between the time an order is entered and the time it is executed, during which the prices could go up or down.
Why market volatility does not matter
Fluctuations and downturns are normal in the stock market. Crashes, on the other hand, are very rare.
Since 1825, there have only been three crashes where the market declined by 30% or worse.
There is really no need to predict a doom-and-gloom scenario every time the market tumbles by a few points. Irrespective of how bad things may seem in the short term, the market always recovers after a period of time and starts climbing up again.
Over the last 35 years (1980 to 2015), the US stock market declined by 14.2% on average during each calendar year.
The annual returns, on the other hand, were positive in 27 out of the 35 years. The market experienced three steep declines during the time period — 17% in 1980, 19% in 1998, and 14% in 2003.
Incredibly, the annual returns were positive in all three years.
Simply put, short-term losses do not matter at all in the stock market. Over a long enough period of time the market’s trajectory always tends to be upward.
Five strategies investing in a volatile market
Buying during declines: A fluctuating market can offer an excellent opportunity to buy blue chip stock at a bargain. A company with strong fundamentals can easily survive a downturn or even a crash and recover quickly.
Rather than pulling out of the market during a downturn, you can actually make an investment and reap the benefits when the market recovers.
You must, however, learn the reason behind the price drop before investing in a company’s stock. If it is due to the downturn, it’s more like to be a good investment.
If it is due to a company-specific problem — a negative forecast, change in management, or a policy decision that is likely to have a negative impact on hat particular industry — you should need wary of investing in a volatile market.
Make regular investments: This is by far the best strategy to survive market corrections and downturns. Rather than investing in lump sums during specific periods, invest a small amount on a regular basis month after month, year after year.
There are two advantages in following this strategy.
First, you do not have to care about short-term fluctuations at all. Since you are making investments all through the year, you do not have to time the market. Market timing rarely works in any case. Instead, stay focused on your long-term goals.
Second, during a downturn, you will be able to buy more shares with your regular investment, which means you will get a much higher rate of return on your investment when the market eventually recovers.
Do not watch the market: One of the mistakes that many people make is that they check stock tickers constantly and panic when their portfolio, or a certain stock, loses value.
This is precisely why most downturns are followed by a selling spree, mostly by novices who are anxious about losing money in the short term.
The golden rule you need to remember is that stock tickers are for day traders. If you are a long-term investor, there is absolutely no reason why you should be concerned about the market’s performance on a daily, weekly, or monthly basis.
Selling during a downturn: If you are looking to convert your traditional 401(k) or IRA account into a Roth account, a downturn is the right time to do it. If you convert it while the asset prices are high, you are likely to incur a hefty tax bill.
On the other hand, if you convert it during a downturn, you are likely to incur a much smaller tax bill, thanks to the decline in asset value.
Invest in a professionally managed fund: If you find it difficult to manage your portfolio in a volatile market, it might be a prudent idea for you to invest in a professionally managed fund.
The performance of these funds is generally not dependent on market conditions, since they are managed in such a way that they generate profits even during a downturn.
If you do not mind the costs involved, it can actually be an excellent long-term investment for you.
The truth about investing in a volatile market
Irrespective of what causes it, market volatility is a reality that cannot be wished away.
Based on this understanding, rather than waiting for the right time to enter the market, you should develop a solid investment strategy.
The goal is to make investments that can withstand the fluctuations caused by market volatility while creating solid long-term results.