Taking Advantage of Volatility - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 20 October 2012
Taking Advantage of Volatility A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
On a day-to-day basis, markets move around a lot. On a given day, it is fairly common to see the stock market index move by more than 1%, and sometimes closer to 2%. Over a longer timeframe like one year, it is not uncommon to see the stock markets move by 20% or 30%, either up or down.

What is clear is that stock markets, and most other markets too, are very volatile. There is a lot of risk involved when investing in the markets, and this is reflected in the volatility of asset returns. Have we ever thought why volatility is so high? Does it even make sense that volatility should be so high?

Let's take a stock market index as an example. In any given year, the markets may go up or down by 20% or more. But what about the underlying companies inside the stock market? The fact is that the earnings of these companies don't vary by nearly the same amount. The earnings of companies on average are unlikely to move by more than 5% in a single year.

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When we buy stocks, we become part owners in the companies whose shares we hold. We are buying the future earnings of those companies. The future earnings have low volatility, yet the price of buying those earnings is extremely volatile. There is some inconsistency here. Why do prices vary so much, when earnings are a lot more stable?

It turns out that one of the main reasons for this is risk aversion. Risk aversion tends to have a much bigger impact on stock market movements than earnings. The good news is that we can take advantage of this. People sell stocks when they are fearful (i.e. high risk aversion), and they buy stocks when they are greedy (i.e. low risk aversion).

The buying and selling due to changes in risk aversion usually has little to do with the earnings of the underlying companies. And this is where we can take advantage. You've heard it before: Buy when others are fearful and sell when others are greedy. The high level of volatility we see it markets today confirms that strategy still holds true.

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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1 Responses to "Taking Advantage of Volatility"

arun c desai

Oct 21, 2012

absolutly correct i have earned money with this statagy

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