High Volatility and Investing
High Volatility and Investing
During volatile times, many investors get spooked and begin to question their investment strategies. This is especially true for novice investors, who can often be tempted to pull out of the market altogether and wait on the sidelines until it seems safe to dive back in.
The thing to realize is that market volatility is inevitable. It’s the nature of the markets to move up and down over the short-term. Trying to time the market is extremely difficult. Even long-term investors should know about volatile markets and the steps that can help them weather this volatility.
Volatile markets are usually characterized by wide price fluctuations and heavy trading. They often result from an imbalance of trade orders in one direction (for example, all buys and no sells or more sells and less buys).
One explanation is that investor reactions are caused by psychological forces. This theory flies in the face of efficient market hypothesis (EMH), which states that market prices are correct and adjust to reflect all information. This behavioural approach says that substantial price changes (volatility) result from a collective change of mind by the investing public.
It’s clear there is no consensus on what causes volatility, however, because volatility exists, investors must develop ways to deal with it!
Beat the myths !
‽ One common myth about a buy-and-hold strategy is that- Holding a stock for 20 years is what will make you money.
√ Long-term investing still requires homework because markets are driven by corporate fundamentals. If you find a company with a strong balance sheet and consistent earnings, the short-term fluctuations won’t affect the long-term value of the company.
In fact, periods of volatility could be a great time to buy if you believe a company is good for the long-term !
‽ Large cap stocks are sure bets
√ While companies with a long track record and an established business make for attractive investments, they may not turn out to be fast appreciating stocks.
One of the reasons is that these stocks have already given a decent return in the past and have a higher base.
Secondly, such stocks are widely covered by a number of analysts. As a result, the ability to generate excess returns is severely limited.
‽ If the stock has done well in the past, it must do well in the future too…
√ Warren Buffet often jokes that if the past was what the market was all about, then librarians and archaeologists would be the wealthiest people in the world. Volatile markets can be as testing and cruel on old stocks as well as newbies.
‽What Goes Up Must Come Down
√ The stock market operates by itself driven by performance, demand, potential and stability or ‘financial soundness’ and no laws can be applied to it.
Bear markets do happen but bullish markets are equally common.
The stock prices are a reflection of investor sentiment and the potential of a company in an industry. You have to find a company with an excellent management team that has a stock price on an upward trend and it will continue to be on an upward trend. The selection is extremely important.
How to weather the storm!!
Only when the tide goes out do you know who has been swimming naked, Warren Buffett once said. This is apt for so many investors who jump into bull markets, throwing caution to the wind.
Timing the market or time – in – the market?
For the common man, both are equally intimidating. But which of these is the “right” way of investing?
The most common is, tactical and technical timing. Buy/sell decisions are based on either price movements or, in a more evolved form, on various technical parameters. The price-earnings (PE) ratio is often preferred. The rule here is simple, buy when the PE ratio is low and sell when it is high. The rewards of doing this systematically can be substantial.
On the other hand, for those who believe in time-in-the-market – Median returns generated by investments across various time periods are a good indicator of the rewards of “time in the market”. Median returns are satisfactory once a threshold of five years has been crossed. As expected, the case for patient investing is a strong one. Data show that the chances of loss lessen with more time spent in the market
The unequivocal answer to the question, therefore, is simple. A rewarding investment experience needs both, because the ability to spend the required “time in the market” needs good “market timing”.
Investing discipline will allow you to naturally ‘buy at lows and sell at highs’ and win over the emotions of greed and fear.
Sneha R
Dilzer Consultants Pvt Ltd