How to Capitalize on Market Volatility

How to Capitalize on Market Volatility

If you have been following global stock markets recently you are probably having a hard time making sense of all the sharp upwards and downward moves. It seems as though every day a different piece of information comes out of China, Greece or the Federal Reserve and the markets swing wildly in one direction or another. While over the long run investors in the stock market have done quite well, the short term can be quite unpredictable and trying to predict which way a stock will move in the next couple of months can be a crapshoot at times. One common piece of advice given out to investors is to capitalize on times of volatility to add to your existing positions or to purchase high quality companies at a discount. This philosophy has been used by Warren Buffet over the years and while we aren’t about to argue with the most successful investor in the world, there are some alternative strategies to capitalizing on volatile markets.

Volatile markets can present some great opportunities for investors to make some excellent returns in the short-run provided they are emotionally disciplined. It’s all too easy to adopt the mass hysteria being breached on all the business news networks but if you can detach yourself from the constant stream of doomsday scenarios being spewed your way you may be able to identify some great opportunities. First of all, when a piece of news comes out that the market perceives as negative they will often sell off the stocks that are impacted by this news. Additionally, if the news is more macro (impact the economy at large) all stocks might experience a big sell-off. Often the market’s reaction can be overblown and the market will creep back up. Likewise, the market may overreact to good news creating some opportunities to short sell a stock in the short-run.

If you believe the market has become too volatile (or too calm) you can actually invest in the overall volatility of the market! There are several stocks out there that track the VIX – short for Volatility Index. This does not measure market performance upwards or downwards but rather the sharpness of these movements. If the stock market moves sideways or moves upwards or downwards slowly, the VIX drops. One stock to take a look at is the Daily Inverse VIX Short or XIV ticker symbol. This stock aims to perform the exact opposite of the daily movement of the VIX – so if the VIX spikes by 10% this stock would drop by 10%. If you look at a chart for this stock over the last year you will notice it fell off a cliff in August when the market volatility spiked. Keep in mind this tracks the daily movements – see our article on inverse ETFs to explain what impact that will have on your investment over the long run

Like all investment strategies, profiting in volatile markets requires discipline and emotional detachment. You need to separate yourself from the market hysteria and identify oversold or overbought equities or an overall market that is too active (or not active enough!)

Michael Smith

How Diversified Are Small Cap ETFs? What is an Inverse ETF?