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What Is Volatility And How Investors Can Beat It

Volatility has become a term mostly associated with negative aspects of the markets and investors are normally fearful of rising volatility. However, thinking negatively about the fast paced changes in the markets on all occasions is unnecessary. Investors have to bear in mind that markets have a mind of their own and can react in a rather hazy manner to some factors which lie beyond our control. One effective way to deal with volatility is to stay the course despite overreaction in the market. Normally, the volatility is less when the markets are locked in a one way trajectory.  At times, the stock market goes up one day, and then goes down for the next two before rising yet again. A continued trend like this, without an apparent period of stability and calm is normally considered to be a time when markets are displaying high volatility. Volatility in the stock market is arguably one of the most misunderstood concepts in investing. Simply put, volatility is the amount of price changes a stock experiences over a given period of time.

The domestic equity markets have been hitting record highs on a persistent basis in recent weeks. The benchmark NIFTY and SENSEX have witnessed a strong upmove, soaring more than 10% from year to date. The markets had seen a rather rocky start to the year before rebounding in April 2018. The volatility of the local markets, as measured by an index called as India VIX (in annualized %) has been locked in a tight range over last few months and has not been impacted much by the repeated bursts of upsides in local stocks.  The index indicates the investor’s perception of the market’s volatility. The index fell to an all time low near 8.8% in May 2017 and stayed in a tight range before soaring near its one year high of 24% in February this year. However, it has slipped thereafter and has moved in a broad band of 12-13% in last three months or so. A high India VIX value would suggest that the market expects significant changes in the Nifty, while a low India VIX value would suggest that the market expects minimal change. It has also been observed that historically, a negative correlation exists between the two.

Increased volatility or rates of change in share prices normally take place following intense unrest in sentiments owing to some solid developments backed by clear facts and certain data. Technology has increased dissemination of information and news instantly. This has in turn affected the investor sentiments, leading to markets reacting in a quicker and much more pronounced manner. While the broad indices may appear to be resilient in their stride, individual stocks tend to see heavy large price swings in either direction. Here are a few tips for investors to not get caught in the volatility vortex:

Focus on earnings: The stock market volatility you typically want to avoid is downside volatility. All major market tops coincide with high valuations and this is quite true for individual scrips too. This makes fundamental aspects a critical part of your trades. Focus on the company earnings and also check the performance of peer group. It is essential to turn away from overpriced investments and rather find stocks which still have potential to rise in tune with their earnings growth.

Be clear about losses: In a falling market, it is very useful to have a clearly defined maximum drawdown plan. This means that an investor should be clear in his mind about the maximum amount of loss he can bear from each of his investment. This policy serves as an integral part of your risk management strategies. Do not let large portfolio drawdowns destroy your long term returns particularly when volatility is on a high.

Review and reshuffle your holdings: Investors have to be flexible in their approach. Once you are empowered with the knowledge from necessary analysis and have mapped out your risk management plan you can choose an appropriate asset allocation. Be open to allocate more aggressively to undervalued assets and avoids assets that do not provide a margin of safety.

Know the reasons behind volatility: Many stock brokers in India are providing clients with plenty of market research and investing ideas. While, it is not essential to keep abreast of each and every market moving update given by online investment brokers, it is generally a good idea to be aware of such insights particularly when markets are showing heightened volatility and a clear direction is not in sight.

Conclusion: Instead of reacting in a panicky manner to the volatile moves in markets, investors should approach short term fluctuations are a part and parcel of long term investment. Be clear about your financial needs and objectives and stick to them. Understand the reasons behind the market moods and use them to your advantage. The sudden fall in stock prices might act as an opportunity to add to your kitty some attractive and sound stocks. With proper groundwork and some additional efforts in learning about the underlying reasons about volatility, the investors can insulate themselves in testing times.

Blog by : Ashish Ajmera

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