Market volatility has never been a deterrent for traders and investors. After all, large price swings are what traders live for, and investors usually have long-term strategies that take short-term price movements into account. However, during times of extreme volatility, even the savviest of financial experts tend to take a step back and carefully strategise their next moves.
The coronavirus crisis of 2020, is a textbook example of how unpredictability can plague financial markets. As the virus continues to spread around the world, affecting more people, markets crash across the globe, showing large fluctuations in what were previously considered the stablest of assets. The market has gone through many cycles of crashes and rebounds and had both traders and investors rethinking their strategies.
So how do they navigate such extreme conditions? Here are a few possible scenarios:
Traders: Looking for Price Swings and Going Short
Short-term traders often thrive during periods of high volatility. However, when markets become unpredictable, some of the most basic forms of decision-making, such as relying purely on technical analysis, go out the window. When markets are reacting to a global crisis, a fundamental factor such as an announcement regarding a countrywide lockdown or a new stimulus package can often cause markets to react instantly, and sometimes not in the direction for which the trader was hoping.
Therefore, some traders shift their focus to news headlines, rather than technical analysis models. Moreover, since some of the larger movements in markets seen in such times are downward trends, traders often opt to open a larger number of short (SELL) positions than they would usually. This type of trading tactic is high risk, since it is not uncommon for sudden price swings to bring positions down to zero — especially when utilising high leverage. The short sell option can also be used as a hedging tool, to manage risk in combination with long positions.
In addition, traders may also reconsider their leverage levels. Many traders often work at high leverage in an attempt to maximise profits. However, since losses are also leveraged, when markets are showing tremendous price swings, lowering leverage can reduce losses in case markets don’t go their way.
Investors: Hedging and Looking for Discounts
Warren Buffet once said that if you don’t intend to hold a stock for 10 years, don’t hold it for 10 minutes. This is often the case with long-term investors, who base their portfolios on shares that will yield returns over many years, and sometimes give them steady dividends. However, when even the most stable of stocks begin showing significant declines, even the most reserved investors may begin reconsidering and restructuring their portfolios.
One common practice is to try and hedge investments with safe-haven assets such as gold, or stocks from companies that are actually benefitting from the specific peril that is gripping markets. For example, teleconference company Zoom skyrocketed during the coronavirus crisis due to increased demand, registering double-digit gains and reaching one all-time high after another.
A different approach investors may take is to see this as an opportunity, rather than a crisis. Large, well-established companies tend to weather such storms by relying on cash reserves or pivoting some of their operations, and could potentially regain many of their losses when the crisis is over. Investors would often look for such companies and invest in them during the crisis-driven downtrend, considering it an opportunity to buy shares at a significant discount.
Sitting out the Storm
Of course, some traders and investors choose not to choose by staying out of markets and waiting for the scenario to play out. Such an approach is one of the reasons some asset classes that usually have inverse relationships, such as gold and currencies, for example, move in the same direction during such crises. Instead of traders and investors moving their funds from one asset class to another, they choose to “sit” on their cash and pull out of all trades.
Naturally, there is no right or wrong way to handle these conditions of high volatility. Each trader and investor should make their own decisions, depending on their capital, risk appetite and strategy. The only guideline that is universal during such times is extra caution. No matter the type of investment strategy, traders and investors should be very careful with their decisions, keeping calm and taking whatever precautions they can.
Here at eToro, we encourage our users, whether they consider themselves traders or investors, to exercise caution. High volatility can be tempting, but when markets are changing so rapidly, some restraint is always a wise choice.
Whether you are an investor or a trader, on eToro you will find all the tools you need to navigate these volatile times.
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