One of the qualities that can make investing in the stock market so exciting is how fast it moves and reacts. Prices are constantly changing making it a challenge to keep up with what’s going on unless you’re sitting in front of a trading monitor. As a result, you might feel nervous about when to place trades, especially in uncertain market conditions. The good news is there are several easy steps you can take to better navigate your trading decisions during volatile markets. Here’s a look at some of the risks of volatile markets and a few ways to help you minimize losses.
Risks Of Volatile Markets
How much volatile markets may affect you can depend on the types of assets you hold, the total amount of money you have invested, and how you react to changes in the market. For instance, if you have highly concentrated positions, you are bound to face larger gains or losses due to having a high-risk portfolio.
Some examples of risks that investors can be exposed to during volatile markets are listed below.
- Being over concentrated in single name stocks, specific sectors, or risky investment styles could lead to larger percentage declines in your portfolio versus major indices such as the S&P 500.
- Focusing too much on the short-term and holding excess cash could lead you to lose purchasing power due to inflation and underutilize strategic trading approaches such as dollar cost averaging to methodically leg into investments on a regular basis.
- Emotions can be hard to control when you start to see red everywhere. Panic selling when a stock price temporarily declines on a sound investment could derail your long-term investment goals. On the other hand, if a company is failing and its stock price starts to decline rapidly, failing to lock in some of your profits or cut your losses could be quite costly.
- Getting too distracted by losses on your existing positions could also cause you to overlook favorable buying opportunities that could help you gain exposure to quality names trading at depressed levels before a rebound.
Bring Your Asset Allocation Back In Line
When the markets seem more unpredictable than ever, it’s a good idea to take a quick look at your portfolio’s asset allocation. Due to fluctuations in the markets, it’s possible your positions may have shifted out of line with your target ratios. For example, your stock to bond ratio may have shifted from a 60/40 split to a 50/50 split. Consider the benefits of rebalancing to help your long-term investment goals stay on track.
It’s also worth checking if you are heavily overweight in any one area of the market. Concentration risk tends to rise in volatile markets. Reevaluate concentrated trading strategies such as those heavily weighted in single name stocks or individual sectors.
Dollar Cost Averaging
DCA or dollar cost averaging in an investment method that involves investing a fixed amount of money in an asset on a consistent basis over time. It can be useful for investors who would otherwise choose not to invest at all or who are unsure about how to determine entry points into a stock or ETF.
If you want to avoid having too much cash on hand, regularly investing a set amount of money into the markets on a monthly or biweekly basis can help you stay active, deploy cash, and avoid feeling like you’re missing out.
Sell Stop Orders
Do you want to protect your gains on a profitable position or limit your losses on a particular holding in today’s volatile markets? One common trading strategy many investors use is to place sell stop orders, otherwise known as stop loss orders.
What a sell stop order does is it places an order to sell shares of a stock when its price reaches a “stop” price that you indicate in the order within a specified time frame. The stop price must also be lower than the current stock price to be valid. It helps to understand how a sell stop order works with this example:
Travis owns 1,000 shares of Stock A. It’s currently trading at $100 per share. He has done well on his position and wants to lock in some profits if the stock price has a steep decline in the next couple of months. Travis decides to place a sell stop order for 500 shares at a stop price of $90 for 60 days.
If at any point during those 60 days Stock A drops in price to $90, Travis’ sell stop order will be triggered and a market order will be placed to liquidate his 500 shares. The actual execution price of the sell may not equal $90 exactly, but it should be pretty close depending on how quickly his broker is able to complete the trade. What if the stock price never drops to $90? The order would simply expire and Travis would be left with all 1,000 shares.
The nice thing about a sell stop order is that you can set it and forget it during your designated time frame. No matter where you are or what you’re doing, you can rest assured that if your stock is on the decline and hits your stop price, your order to sell will be placed automatically. If you change your mind and no longer want to sell, you can simply cancel the trade if it hasn’t been filled before the order’s duration has expired.
Buy Stop Orders
A buy stop order has the same principles but in reverse. For example, if you are interested in buying shares of Stock A if it starts to show a rising trend in price, you can place a buy stop order. If the stock price reaches your stop price, your order to buy shares will be triggered at market. This can help you to make purchases before a stock price runs away and gets too high.
Limit orders enable investors to purchase or sell a stock at a specific price (the limit price) or better. Let’s say Stock A is currently trading at $100. If you are willing to pay $99 or less to buy 1,000 shares of Stock A today, you could place a buy limit order with a limit price of $99.
If your broker can meet or beat that limit price before the end of the trading day, your trade to purchase 1,000 shares will be triggered and executed. In other words, your execution price could be $99.00, $98.99, $98.95, etc. If the price stays above $99 the rest of the day, your order will expire. On the flip side, a sell limit order can only be executed at the actual limit price or higher.
Stop Limit Orders
Now that you are familiar with stop orders and limit orders, one step further is a stop limit order. In simple terms, a stop limit order is a combination of the two trade types and offers investors added precision.
First, you designate a stop price, share quantity, and duration just like with a plain stop order. Next, you choose a limit price. The order will only be triggered if the stock price reaches the stop price and the order can be filled at the limit price or better.