Tips to trade shares in a volatile market
October is historically the most volatile month of the year – here are some tips to navigate it.
- October and November are expected to show higher volatility
- One proven strategy is to simply ignore volatility
- Use limit orders to minimise losses and increase profits
- It can be a good time to buy stocks at a discount
Buckle up, traders, because we're heading into the most volatile month of the year.
There doesn't appear to be much logic in it, but October tends to see bigger stock price swings than in any other month. With 2020 already the most volatile on record, you may be wondering how much crazier it can get.
Part of this phenomenon may be chalked up to a psychological effect. Two of our biggest stock market crashes – Black Monday in 1987 and 1929 – occurred in October and the month has consequently built up a reputation among traders. Whether rational or not, traders are on high alert at this time, which could result in a surge of market activity.
Another explanation is that it's the month leading into US elections. Since the stock market usually favours one party more than another, stocks can react dramatically as politicians ramp up last-ditch efforts to win voters.
While Australia's stock market tends to follow the lead of Wall Street, there's a lot happening on the political front locally too. In October, we'll be hearing the results of the delayed budget, set to be one of the most important on record.
Regardless of what happens in October, it pays to be prepared. So what can investors do to navigate stock market volatility? Below are four tips to get you started.
Less is more
Ask investment guru Warren Buffet what to do when volatility spikes and his response is probably along the lines of doing nothing at all.
Buffet's famous "buy and hold" strategy follows the idea that you're better off buying good-quality companies for the long term rather than trying to beat the market with high-frequency trades.
Although this might seem counterproductive, research has shown that stock portfolios where fund managers actively buy and sell stocks in response to price fluctuations tend to be worse off over many years than an index fund that simply mimics the market.
While stocks tend to be volatile day to day or even year to year, it follows that a good-quality company should see prices rise steadily over a decade or more, provided it's continuing to grow and has a good balance sheet.
Simply ignoring your portfolio might seem like the easiest option, but experienced investors will tell you just how hard it is to sit on your hands when the market is volatile.
It's not uncommon for investors to sell their holdings out of panic as the market is crashing, only to find they've missed the chance to ride the recovery and must buy in for a loss.
While it's not advisable to ignore your portfolio altogether, the trick is not to sweat the small stuff. Set a 10- to 20-year plan, purchase good quality companies and ignore much of what happens in between.
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Take advantage of buying opportunities
Although risky, a volatile market can be one of the best times to make a profit.
When prices dip, it's an opportunity for investors to scoop up quality companies for discount prices, similar to what we saw occur in March and April. The key is to be ready for this to happen at a moment's notice.
Many investors have a shopping list of companies at hand in preparation for a stock market correction or heightened volatility. By setting price alerts on your share trading app of choice, you can be notified when a company you're following has fallen to a desired price.
Of course timing the market is tricky. Unless you're very lucky, you're unlikely to get in at the best possible price. However, if you're prepared to hold for the long term, such volatility can be a great opportunity.
Use limit orders
If the stock market is volatile, it's a good idea to use limit orders (also called conditional orders) to buy stocks rather than market orders.
With a market order, you're giving an instruction to buy a stock at the next available price, which can be hazardous if prices are changing quickly.
Whereas, when you set a limit order, you can select a specific price or price range at which you'd ideally like to buy or sell shares, making them an invaluable tool if you're trading during a volatile market.
The downside of using limit orders is that while market orders are guaranteed, limit orders may never go through if your price isn't met.
There are at least a dozen types of limit orders and each meets very specific needs. Among the most popular is the stop loss, where a trader can set a sell order for a stock if it falls below a certain price – hence minimising losses should a stock crash.
Trading platforms also call conditional orders by different names, as I mention at 6:12 in the video below. For instance, eToro calls its basic limit order a "rate order."
For more information on buying shares, you can head to our comprehensive guide or check out the video below.
Trade the trends
Active traders are in their prime element when the market is volatile.
Lower brokerage fees mean that traders can earn a quick profit from short stock or commodity price movements. When volatility is higher, the opportunity to make big money quickly also increases.
Day traders or "swing traders" do this by trying to predict future trends, mostly using price charts, known as technical analysis. For example, a trader might follow a stock's 21-day moving average, which is the average price of a stock over 21 days. If the price sits above the moving average for a number of days, it's a signal that investors are feeling bullish and the stock may continue to rise. The opposite is also true.
However, there are many risks that come with day trading strategies. Trying to time the market is hard and even advanced traders get it wrong a lot of the time.
And typically day traders use leveraged contracts to boost their earnings, often through options or CFDs, rather than buying stocks directly. For example, say you buy $1,000 of a company's stock, this would mean you'd earn $100 if the price rises by 10%. However, by using leverage you could enter a contract to buy 10 times the number of stocks, which would see your earnings rise substantially.
Of course, if the price goes in the wrong direction, your losses will also be amplified, making this practice much riskier than regular investing. For this reason, only experienced traders should attempt these strategies.
Buy shares with eToro
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