There is no question that this is a superior environment for active trading. The “fear index” VIX recently hitting 50 combined with ultra wide swings provides traders with numerous opportunities for profit. These moves are triggered by the economic confusion that seems to be affecting the entire global system. The Eurozone debt crisis, Standard&Poors’ US downgrade, and whether or not Ben Bernanke will institute QE 3 all add to the inherent volatile nature of the stock market. However, these same moves that lead to outsized profits can also result in heavy losses for traders not skilled and prepared for the volatility. This article will provide 4 critical tips for dealing with market volatility.
Not getting married to any one position is a key for success in volatile markets. In fact, it’s a key for success in any market condition. Trading skill combined with a robust trading platform can enable savvy traders to quickly take profits or cut losses within ultra volatile environments.
Buying after a very sharp decline and selling after a sharp rise can be a tactic for profiting in heavy volatility. Just take a look at a recent daily chart of the DJIA or S&P 500 to see an example. The snap back rallies and the subsequent plunges are custom made for fading.
Options can be a powerful tool to use in volatile markets. A strategy known as a straddle can be used to profit from sharp moves, even if you don’t know the direction. A classic example of an excellent time to use a straddle strategy was prior to the pending S&P downgrade. No one knew for certain what way the market would move after the rumor became reality, creating the perfect straddle environment. This strategy provides profits if the underlying instrument moves substantially in either direction. Straddles are the simultaneous buying of a Put and a Call at the same strike price and expiration date. This position has the trader covered in the case of the economic surprise, bullish or bearish. Just keep in mind that the subsequent move must be aggressive for the straddle to profit. You are betting on the magnitude, not direction, of the move.
If you are able to recognize a solid move in one direction, jumping on board can lead to profits. This so called trend trading can work nicely for short term traders, as many moves even in volatile markets can last for several days or longer prior to reversing.
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