Every financial market has a certain level of volatility because asset prices are always changing. While volatility can lead to significant losses, traders would never make money if asset prices never moved.
Volatility is the degree or speed at which prices in a specific market or for a specific asset fluctuate. High volatility means there is a higher probability of making a profit quickly, but also the probability of making losses.
Trading in volatile markets means being a disciplined trader or investor and having the right strategies to maximize upside and minimize downside. Here are the best strategies for managing risk while leveraging volatility for maximized returns.
Be Prepared
Because trading in highly volatile markets means facing increased risks, you must be prepared mentally and tactically. This means you have to be mentally comfortable trading when volatility and risk are higher than normal, and that you are realistic about potential losses when doing this.
Once mentally prepared, you should put control measures in place and include them in your trading plan. Critical components of such a trading plan are position size and stop order usage. Many trades place smaller trades when the market is volatile, meaning they commit less capital for each trade.
You can also use stop orders that limit losses by allowing them to trigger sales when prices fall to a specific level or stop trades when this happens. When doing this, you should ensure the stop prices are much further from the prevailing market price than they would be when the market is less volatile.
This strategy works by keeping the exposure the same in volatile and calmer times. The much higher or lower price triggers should ensure trades are not stopped or sales triggered when prices swing higher than expected in a single period.
Remember that you can always execute your stop order before hitting the stop price. You can do this if market conditions change or there is a big price gap between your buying price and the current market price and, therefore, a chance of significant profits.
Trade Between the Lines
You can also trade the trends where you trade between the resistance and support levels. The resistance level is the highest amount the asset’s price will not surpass, while the support level is the lowest price it will not cross.
If the price starts approaching resistance, you should prepare for it to drop because the market will correct itself. If the price starts trending towards the support level, you can expect the market to reverse and for the price to increase.
The best thing about this technique is that you can see trends like this on a price chart, whether you are looking at an intraday chart or a three-month one.
Since you are already trading in a highly risky market due to its volatility, you need to remember that this is an advanced technique. It requires an in-depth understanding of the behavior of investors and the financial market, and the ability to read numerous charts to come up with insights and conclusions about price movements. You can also learn about other expert trading techniques from professional traders who have used similar techniques in the past.
Watch for Breakouts
The previous strategy entails trading within the resistance and support levels. Some traders go the opposite way and instead trade based on breakouts. The breakout strategy entails waiting for the stock to pass the resistance or support level and remain there for a while.
If the price breaks out from the resistance and support bracket, that could signal the beginning of a trend you can take advantage of.
For example, breaking out of the resistance level means it is time to buy so that you can sell at a higher price as long as this trend holds. If the opposite happens, you can short the trade or wait for the price to fall low enough so you can buy the asset at a much lower price.
Watching for and trading on breakouts requires that you keep a close eye on the price trend and use analytics tools to know when a reversal is imminent. Reversals can happen very quickly, especially if the price fluctuation was caused by something temporary like a positive or negative news story.
You can also use stop-loss levels to protect your investment by selling the asset before it falls too far or stopping trades so you do not enter losing positions.
Use News to Leverage Price Movements
We have hinted at this above, but it needs more elaboration. News moves the financial markets significantly. It can cause prices to swing wildly, leading to fluctuations you can take advantage of. As with all strategies when trading in volatile markets, there is potential for losses if the news doesn’t favor your analysis prediction.
The key to success with this strategy is making trades before news breaks or goes mainstream. You can use numerous news and information sources to know what is happening in the financial sector to predict what will likely happen.
For example, there could be news of an indictment against a CEO. In such a case, you can expect that the price will start to fall as the news trickles down, and there will likely be a rapid fall once the news goes mainstream.
The reverse of this is knowing a merger or acquisition is coming. It is much harder to hide such events in the digital age. Knowing they are happening can help you profit and then exit your positions because the gains from such news might not last unless you are investing for the long term.
Capture Profits When You Can
With the massive price swings inherent in volatile markets, profits can disappear in a second, and losses can appear from anywhere. Savvy investors sell portions of their positions as asset prices rise and profits increase to get that money out of the market and continue getting gains from the remaining position.
You can also set very tight stop orders to minimize losses and get your money out of the market as soon as signs of a loss are detected.
Volatile markets present significant risk for investors. However, riskier investments typically have higher-than-average returns, so they are something many investors experiment with. If you decide to invest in them, you need robust investment strategies and to keep an eye on the market so you can enter favorable positions and exit unfavorable ones faster and easily.
