This year is all set to be a very volatile one for the stock markets. The stock market is trading near record highs but it’s not in sync with the economy. Though vaccines will be rolled out at a large scale in the next few months, macro indicators remain weak and it is safe to say that traders can expect a lot of movement in the markets.
A volatile market means a lot of price fluctuation that gives traders the opportunity to make higher than usual profits. However, as volatility increases, so does the risk of incurring a loss. Here are four steps to keep in mind while trading volatile markets so that you can maximize profits and minimize losses.
Identify Trending/Volatile Stocks
The smart choice to make in volatile markets is to only choose stocks that are trending. Often, a lot of stocks move at a steady pace irrespective of market volatility. You want to avoid those stocks. If the stock is upwardly volatile, hunt for stocks that are trending up. If you are a short-seller in a volatile market, hunt for stocks that are declining but haven’t totally collapsed. There are a couple of factors that you can look out for before trading in these stocks.
Choose stocks that have large trading volumes. The larger the volume, the easier it is for you to enter and exit stocks. The worst error you can make is getting stuck in a stock that no other party wants to buy or sell. For example, you can use a stock filter to narrow your vision to 10 stocks that trade between £10 and £50 and have over a million trades for the last 100 days.
You can use a stock filter to filter stocks that have moved over 2.5% daily between the open and close of the market (in either direction) for the last three months.
Often, indices report daily gainers and losers. An easy way to identify volatile stocks is to manually go through this list and figure out which stocks make regular appearances on this list.
Keep an eye out for ‘breakout’ levels
A lot of expert traders use the ‘breakout’ rule for trading in volatile markets. The rule is very simple: Keep an eye out for stocks that are establishing strong support levels and are trading within an effective range. If the stock continues to trade in that range, no action is taken on that stock. However, if the stock breaks out or crosses the upper/lower range, traders buy the stock because it could zoom up/down and create a new range.
During normal trading days, there is a danger that once a stock breaks out, it can lose momentum and slide back into the previous range. In a volatile market, that usually doesn’t happen. Stocks in a volatile market almost always create a new range and move up or down. One thing you have to make sure of is that your break out range is wider than normal.
However, in a volatile market, if a stock creates a false breakout level, the price decline can be huge, sudden and severe. If that happens, there is a danger of a huge loss. It is important to keep a strict stop-limit order so that you can cut your losses.
Place limit orders, not market orders
Markets don’t move in a normal or traditional sense during volatile days. Traders need to ensure they leverage various stock order types to ensure they are focused and disciplined while executing a trade.
So, a market order is an order that lets you buy or sell stock at the current price in the market. For example, Lloyd Bank is trading at £36.74. If you place a buy market order, it will execute the trade at £36.74 during normal times. However, during volatile markets, this could change to £34 or £39 because prices fluctuate wildly in these kinds of markets.
When you place limit orders, your orders only get executed at those prices. For example, if you place a buy order at a limit of £36.74, your broker will execute that order only if the price is £36.74. If the price is over the number, it won’t be executed. However, there is a chance that you might lose out on a good stock because it didn’t hit your limit.
Only deal in short-term strategies
Volatile markets have a great way of lulling you into a comfort zone. This could mean that you might think it is sensible to hold on to a stock for longer than usual. For example, in a regular market, if a stock breaks out, a trader can afford to have a higher price target for the stock before selling it. However, in a volatile market, you have to book your profits quickly.
- You have to set a target or a certain percentage when you will sell your stock.
- If you don’t want to sell your whole position, sell a large part of your position (maybe recoup your principal) and hold the remaining stock to generate more upside.
In a nutshell, understand that the market can change suddenly and be prepared to react when it happens.