With the Federal Reserve holding interest rates steady, investors are seeing increased stock volatility throughout the market. Meanwhile, individual stocks like CVS saw share prices plummet after the healthcare giant cut its profit outlook. These conditions leave investors wondering how best to invest in the face of stock market volatility.
While the answer to this question depends on your investment strategy, there are some basic tips that any investor can use when facing an uncertain market. Here’s how to maintain your investments in the midst of stock volatility.
What Is Stock Volatility?
Stock market volatility simply refers to the degree that stock prices change over time. Naturally, investors should expect some degree of volatility in both individual stocks and the market as a whole. But when the market sees a rise or fall in price by over 1% for a sustained period, it’s considered highly volatile.
Beta: How Stock Market Volatility Is Measured
Economic analysts measure volatility using “beta” values, which compare the volatility of an individual stock against the market as a whole. If a stock has a beta of 1, it means that its volatility is equal to that of the entire market. In other words, if the S&P 500 index rises in value, the individual stock will rise to the same degree.
In contrast, a stock with a beta of less than 1 will have lower volatility than the market or index, and stocks with betas above 1 will show more volatility than the market. It’s not uncommon for tech stocks to have betas above 1 because these represent industries that change more rapidly than other sectors.
VIX: Measuring Volatility Across the Market
While beta values reflect the volatility of individual stocks, investors can use the CBOE Volatility Index, or “VIX,” to measure the market as a whole. VIX values reflect the average volatility of the S&P 500 index on a three-month basis. On average, the VIX value has been just above 20, with higher values indicating increased volatility.
Tips for Investing During High Stock Volatility
In one sense, every investor has the same goals: maximizing gains and minimizing risk. In volatile markets, you’ll need to adjust your strategy to account for price fluctuations. Check out these tips for navigating stock market volatility so you can protect your investments and even come out ahead.
Set a Goal
Your investment goals will determine whether you take an aggressive or defensive posture with your investments. For example, day traders have short-term investment goals, which means that they seek to capitalize on volatile market conditions and profit from major price swings.
Long-term investors, in contrast, remain focused on steady, sustained growth. This means that they should seek strategies for minimizing risk during periods of high volatility.
Use Stop-Loss Orders to Cut Your Losses
A stop-loss order is designed to sell a security once it reaches a predetermined value. Thus, if you have 100 shares of Company X in your portfolio, you can create a stop-loss order if the price plummets to $20 per share. That way, if the price should drop to this point (or lower), you’ll at least spare yourself further loss.
Seize New Opportunities (Wisely)
With prices rising and falling, it can be a good time to seek out undervalued stocks to add to your portfolio. Again, day traders can make this a central part of their strategy — though doing so still requires careful research and planning.
In response, many day traders practice the 1% rule. This means they never spend more than 1% of their total investment budget on any one trade.
Long-term investors can similarly seize new opportunities by setting a limit order, which allows you to buy a stock if the price falls to your predetermined threshold. Your order is only executed if the price drops to your desired level, which may allow you to purchase large-cap stocks for less money if the price should fall.
Focus on Trending Stocks
Some traders may want to take a short position on rising stocks. During volatile markets, you may find that some stocks trend in the same direction as the market as a whole.
Focusing on the beta value can help you pinpoint these stocks, which can lead to some immediate gains. Just remember that this method requires careful research. Even then, there’s still a considerable risk that the market could change direction unexpectedly.
Purchase New Stocks Through Dollar-Cost Averaging
Buying stocks can be tricky in a volatile market. After all, you could pay one price today, and the share price could drop by the next, creating the investing equivalent of buyer’s remorse.
Instead, purchase stocks using the dollar-cost averaging method. This strategy has you spreading your purchase out over the course of days or even weeks.
Thus, if you want to buy 100 shares of Company ABC, you’ll buy 10 shares today, 10 tomorrow, and so on until your purchase is complete. The idea is to spread your purchases so that the price you pay aligns with the average share price over the course of the time period.
Diversify, Diversify, Diversify
Every stock market investor should understand the importance of diversification. A portfolio that contains a wide range of stocks from multiple industries will be well-protected if one market sector takes a major dive.
For instance, a portfolio containing a high percentage of tech stocks can experience major losses during a volatile period. Balancing your portfolio with stocks from other industries will protect against these sorts of swings.
Investing in a mutual fund or index fund can give you built-in diversification. You can always add to your portfolio later on. It’s also possible to diversify your investments across asset classes. If stock market volatility makes you nervous, you might consider investing in bonds or tangible assets like real estate or precious metals.
Consider International Stocks
If the U.S. stock market is going through a period of volatility, there’s no guarantee that the rest of the world is experiencing the same thing. While concerns over interest rates are impacting the stock market domestically, you may find that international stocks are influenced by different factors altogether.
On the plus side, you may find international stocks to be more stable than the current market. But don’t forget to research carefully, as international politics can also impact foreign markets.
Use Derivatives for Hedging
Hedge your bets by using stock derivatives. Stock options, for example, allow you to take advantage of price swings. Put options are basically bets that a stock price will fall, while call options bet on a price increase.
However, stock puts are a bit complex for novice investors. If you haven’t practiced this method before using paper trades, you might consider another method from this list.
Stay Focused on Your Long-Term Goals
Take a breath and relax — stock market volatility isn’t at all unexpected or unmanageable. If you’re a long-term investor, you can weather this storm and see your portfolio grow over time, even if you’re not seeing the ideal conditions at present.
However, it’s still important to monitor your investments and make adjustments over time. But don’t react out of fear or greed, and do remain focused on your goals. Over time, you can see results from sustained, long-term growth.
Do Your Stock Research
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