Is Market Volatility Your Friend or Enemy?

Originally published on, September 6, 2016.

To put it simply, volatility in the financial markets is the amount of movement that a security has over a given period of time. There are a few questions to address in terms of volatility, which, like everything else in life, is essentially a matter of perspective.

Perspective is how we see the world. Like the rest of the world, in investing, our perspective is driven by our objective. It’s generally accepted that there are three types of investors/traders, all of whose perspectives vary greatly:

  • Long-term Investors - These are investors who are typically looking for growth in their portfolio over the long haul. The past 18 months have been relatively boring in regards to movement in the markets. Sure, the S&P is at an all time high, but the high is not that much higher than it was 18 months ago; the more passive longer term investor has not seen much movement in their value unless they are monitoring regularly. One monitoring their portfolio weekly or monthly would see fairly large swings over the past 18 months but overall very little change in value.
  • Medium-term Investors - These investors generally look to move their money around on a quarterly, or even monthly, basis. These types of investors are empowered by greater access to the financial markets than ever before. They’re looking to secure capital growth by nimbly moving their money.
    The type of volatility we’ve seen over the past 18 months can be frustrating for this type of investor, particularly the ones that don’t understand true market movement. Oftentimes, medium-term investors find themselves getting into a position too late, and getting out too early, which can seriously erode their returns. For the medium-term investor how markets move and why tops and bottoms occur are very important for their success.
  • Short-term Traders - These traders look to be in and out of stocks in weeks or days. Looking specifically at the past few weeks, the S&P has found itself in the tightest range it has been in for many years – the most dangerous type of range for short-term traders. Day traders may be able to profit from some intraday volatility, but short-term traders find it difficult to profit in this condition.

How volatility affects different types of traders and investors.

The above chart, which illustrates the S&P’s recent movements, depicts a tight range that almost teases traders to attempt to get lucky and play the breakout. This is where it’s important to examine volatility, and consider whether it may be a friend or a foe.

One common strategy that often hurts short-term traders is playing the breakout. In a breakout strategy the biggest fear is the “false breakout,” when price breaks above a high or below a low and fails. The above chart illustrates that there have been a number of false breakouts in the past few weeks, making it extremely difficult for traders to profit. False breakouts occur simply because the balance between buyers and sellers is tipped overwhelmingly in one direction.

Ultimately, the market boils down to just that – buyers and sellers. Buyers, sellers, and market balance/imbalance are often responsible for market environment and volatility. Educated traders and investors are able to understand a current market environment, particularly in regards to its recent trends and volatility, giving them a massive opportunity to capitalize on genuine breakouts in order to turn as much of a profit as possible.

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