How to Invest in a Volatile Market

Investing is pretty easy when the markets are going up. There have even been demonstrations in the past showing trained chimpanzees picking winning stocks and sectors in bull markets. But when the markets get rough, investing becomes much more difficult. It is when you cannot comfortably pick winning stocks that factors such as discipline and experience come into play.  Fortunately, there are still time-tested strategies that can work in a volatile market. Read on to find out about how to invest in a volatile market.

Takeaways

• Why volatile markets are an opportunity to make money

• Option strategies to trade successfully

• Why regular disciplined buying will make you rich

Options strategies

If you are an experienced investor, then trading options may be the best possible way to take advantage of a volatile market. There are certain types of options trades that allow you to profit (at least to some extent) regardless of which direction the underlying security (stock, in most cases) moves. The most straightforward type of options strategy is known as a bull straddle. This type of trade involves buying the same amount of call and put options on the underlying security at the same strike price. This way, if the stock or ETF moves radically in one direction or the other, you can make a profit. You will have to subtract the cost of the options before computing profit. But a strong move in either direction can leave you in the black.

Strip and strap straddles

Another key type of strategy is the strip straddle. This options trade is most appropriate when you think that the underlying security is more likely to go down than up. The strip straddle is essentially the same as a bull straddle, except that you buy more puts than calls.

This way you will make a bigger profit if the security substantially drops in price. Strap straddles are similar to strip straddles, except that you buy more calls than puts because you think that there is a greater chance that the underlying security will break out to the upside.

The long gut

Another good options strategy is called the long gut. With this strategy, you will buy a certain number of call options that are in the money and the same number of put options that are also in the money.

This type of trade is a debit spread and will cost you some money upfront (just as with the other options strategies mentioned previously). Long guts differ from bull straddles in that the options that you buy with a bull straddle are at least slightly out-of-the-money.

The call ratio backspread

A call ratio backspread is yet another options strategy that you can use if you believe that the underlying security may move in either direction but is more likely to rise than fall. Unlike the other types of options trades describe previously, this one is generally not suitable for beginners. With this strategy, you will both buy and sell calls, but you will buy two calls for every one that you sell. The ones that you buy should be at the money, while the ones you write (sell) should be in the money.

General rules

In all cases, the premiums that you get from writing the calls should be greater than the amount you spend to buy them. You can pick any strike price you want but always keep this rule in mind. A put ratio backspread is the same thing in reverse, where you think that it's more likely that the underlying security will fall in price.

Portfolio rebalancing

This strategy is simpler than any of the options trading strategies, and it can keep your investment portfolio on track over the long run. With this strategy, you can keep your portfolio allocation constant by periodically selling the fast-growing segments of your portfolio and using the proceeds to buy more shares of the slower-growing segments of your money.

Over time, your portfolio will grow more quickly than it would otherwise, and it will also maintain the original asset allocation that you chose when you first bought in.

An insurance strategy

If you do not use this strategy, then certain portions of your assets may end up growing at a much faster pace than others, which means that your portfolio could eventually become overweighted in certain sectors.

For example, if you initially allocate 5% of your portfolio to technology stocks, then they may grow much faster over time than the percentage of your money that you put into government bonds. Ten years from now, your allocation to tech stocks may comprise 15% of your holdings if they are not rebalanced. Rebalancing can help you to stay on track during a volatile market.

Dollar-cost averaging

This simple strategy allows you to buy into a given investment at a lower overall cost over time. This method is particularly useful with mutual funds that allow you to buy fractional shares. For example, you could set up a program where you buy $200 worth of shares in a large-cap growth fund each month.

When the price of the shares rises, then you will buy fewer shares in a given month. When the price falls, you will buy more shares. This will ultimately reduce the average price per share that you pay to invest in the fund. Of course, this strategy will also work with stocks, although you may not be able to buy fractional shares.

Buying low

This is probably the simplest strategy of all. But it can be very difficult to know when a stock or other investment has reached its low point. Look for it to break through several levels of technical support. Then it is probably a good time to keep a close watch on it. You can jump in when you think that it has finished its downward trajectory.

You do not have to get in at the absolute bottom to make money, and the longer you wait, the greater the chance that the price of the security will rebound. Patience can be a virtue, but too much patience may cause you to miss out on the best possible gains. This is one of the key principles of investing when you invest in a volatile market.

Tax-loss harvesting

This is another key strategy that can take some of the bits out of a losing holding. Just be sure to obey the HMRC same day Rule. This rule mandates that you cannot buy the losing holding back until at least 31 days after you sold it. You cannot sell a losing holding and then buy it back immediately and still realize a loss. This applies in many countries, not just in the USA.

The risk you take

You must take the chance that your loser will not substantially rise in price during the waiting period. If it does, then you will miss out on a potential gain over that period. But harvesting tax losses can be a good way to save yourself some money when the markets are down.

You may have holdings that are currently upside down that you plan on holding for the long term. Harvesting those losses can offset other gains that you may have. They may even offset other types of income up to a certain amount.

Maintain a small cash balance to buy with

Occasionally, you may come across what looks like a great buying opportunity. You should always keep at least a small percentage of your investment portfolio in cash.  Then you can use this to jump on a security that you think will rise substantially in price.

Wait until it finishes its run, then sell it and put the proceeds back into cash. Then you will have funds to use for the next great opportunity you see. This is yet another idea for how to invest in a volatile market.

Conclusion

Volatile markets will always provide you with opportunities to make money, even if it is a market correction. The key is to select the  strategies which work for you. This requires understanding yourself and your tolerance to risk. Remember, investing in good quality buy and hold assets means that even in volatile times you can invest with confidence.