How to Invest in a Volatile Market - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 1 June 2013
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- By Asad Dossani, Author, The Lucrative Derivative Report


Asad Dossani
Over the last few weeks, volatility has been increasing in markets around the world. This is certainly the case for the Indian stock markets too. For example, on Friday markets were down over 2% in a single day. When volatility goes up, we should adjust our investment strategy accordingly. What is the best way to invest in a volatile market?

One empirical fact that is important to keep in mind is the relationship between volatility and market prices. The fact is that when volatility goes up, stock markets tend to fall. There is an inverse correlation between the two. This makes intuitive sense. Volatility usually occurs in response to fears of a crisis, and this also causes markets to fall overall.

What this means is that when market volatility is going up, then it is good time to wait before buying any stocks. The high volatility means that stocks will likely fall. However, high volatility can also present excellent opportunities. Following a period of high volatility, market prices are often overly depressed.

High volatility can cause stocks to fall well below their fundamental values. The opportunity comes when this occurs. Following periods of high volatility, stocks are inexpensive, and this is the perfect opportunity to take new positions and invest for the long term.

This reflects the fundamental relationship between risk and return. When the risk (i.e. volatility) is high, prices fall and potential future returns are much higher. If you are willing to invest when others are not, then you can earn strong returns.

Currently, market volatility is leading to falling stock markets. Now is a good time to look for fundamentally strong companies to invest it. Then, once the volatility has subsided and returned back to normal, it is then a good time to buy.

While it is difficult to predict the direction of the market in the short term, it is much easier to predict the level of volatility in the short term. By timing stock purchases to coincide with periods following high volatility, one can maximize potential long-term returns.

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is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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2 Responses to "How to Invest in a Volatile Market"

Kishan Reddy, K

Jul 8, 2013

Volatility, is measured using INDIA VIX Index. If India Vix is taken as a measure for volatility, I have the following doubts. SEBI has recently removed several stocks from F&O. I Think the traders/speculaters in these stocks has shifted their positions front line stocks. As India VIX is based upon Nifty Option prices, Obviously this has impacted India VIX.

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Prasanna

Jun 2, 2013

@but Dossani, is this not the time to sell off some stickily, low value stocks?

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