Market volatility can be an opportune time to make money, but it’s also incredibly stressful.
It’s no wonder that many retail investors “run for the exits” when stock prices drop, but that’s quite the opposite behavior most people take when any other type of asset goes down. Instead of panicking when there are violent swings in volatile markets, react with discipline.
What Triggers Volatility?
First of all, what triggers volatile markets in the first place? Experts have studied the causes of volatility for decades. Some believe political and economic instability are primary triggers. Other commonly believed causes of volatility are declines in investor confidence, imbalances between the volume of buy and sell orders, unforeseen earnings results, and oversupplies of IPOs.
Additional triggers for volatile markets are thought to include instability in global economies, real-time news reports, dark pools, short sellers, intra-day trading activity, large stock blocks placed by institutional investors and algorithmic trading.
Get Disciplined During Volatile Markets
When you’re working hard at your job and losing a ton of money in the markets, you likely feel like you’re stuck running in place or worse, falling behind and getting buried beneath an impenetrable pile of rubble. It can be so tempting to just give up all hope, stop trying to succeed, and drown in your sorrows instead.
Before you walk off a mental cliff, take some solace that you are not alone in your pain and that down markets are rarely permanent. Here are some ways you can stay disciplined during volatile markets and stay focused on your long game.
Grab Your Telescope, Toss Your Microscope
Retirement accounts like IRAs and 401(k)s can really suffer from rash trading decisions made in a panic. Think about your long-term goals to help prevent yourself from overreacting to short-term volatility. It also helps if you look at the S&P 500’s historical performance. Look at any 10-year period and the market has shown a gain.
Another way to try and have less volatility in your investment portfolios is to focus on blue-chip companies versus speculative growth companies. Healthy balance sheets and consistent earnings help profitable companies have lower volatility than the overall markets. You can also sleep better at night avoiding companies with weak earnings and selecting those who focus on their bottom line.
And also remember that market fluctuations are normal and there have been bigger swings in the past that the markets have recovered from. Take a look at the CBOE Market Volatility Index (VIX) below, which measures the implied volatility of the S&P500.
Utilize Dollar Cost Averaging
Another popular investing technique many investors use to stay disciplined during volatile markets is dollar cost averaging. This involves legging into an investment over a period of time using equal contributions of an available balance. In other words, you don’t put all your cash into the markets at once, you do it in regular stages.
Lump sum investing is the opposite of dollar cost averaging, i.e. putting all of your cash into an investment at once. It’s worth noting that studies have shown that lump sum investing performs 66% higher than dollar cost averaging. But due to the disciplined nature of dollar cost averaging, some investors much prefer it, especially since it does reduce the risk of investing all of one’s cash right before a market crash.
Contemplate Paying Down Debt
If volatile markets are causing you too much stress, an alternative means to stay disciplined with your investments is to pay down debt. Begin with the loans that have the highest interest rates and work your way downwards.
You can also shop around and consider consolidating your loans and refinancing as a way to save money. At the end of the day, you won’t lose paying down best. Perhaps you might just win less. But it feels good to put your cash towards reducing debt obligations, something you can fully control unlike the stock markets.
During times of volatile markets, some investors find stocks with low beta attractive to own. So what is beta? Beta measures how sensitive an investment is compared to market movements such as the S&P 500. Stocks with a beta of 1 move in line with the market. Those with a beta less than 1 indicate a stock is less volatile than the market and vice versa for beta values over 1. Some sectors that have historically had low betas include Consumer Staples, Utilities, and Health Care.
What’s the downside? Over the long run, low beta stocks can underperform in a growth environment compared to high beta stocks. Another way to think about it is if the economy is growing at a rate of X% and is expected to continue at that rate, investors would prefer to own reasonably priced stocks that are growing at faster rates than X%.
Review Your Risk Tolerance
If you feel your stress level rising and your appetite for risk dropping during volatile markets, you are not alone. Your brain’s reactions to market volatility could actually be making you more risk averse. For example, a study of stock traders in London found the group’s cortisol levels (the stress hormone) rose nearly 70 percent during a two-week stretch of volatile markets. That’s a significant increase in stress! Forty-four percent of the participants became more risk averse as a result of their heightened stress levels.
If your stomach won’t settle during volatile markets and you can’t sleep at night, it could be time to re-evaluate your risk tolerance and investment goals. Write things down and be as analytical and methodical as possible when your emotions are running high to help yourself stay disciplined. Dialing down risk could turn out to be just what the doctor ordered.
Take A Deep Breath And Move Forward
When volatile markets have you feeling queasy, remind yourself that they are normal and aren’t just a recent, rare occurrence. Market fluctuations are just a part of investing. Do your best to get your emotions in check. Meditate if you have to; it’s great for lowering stress and helping you focus. In uncertain times, it’s important to review your portfolios, rebalance if needed, reassess your financial goals and put your capital to good use. Over the long run, the markets have proven their resiliency. So should you.
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