Monday, November 2, 2015

Volatility in the markets - friend or foe?

Small investors should take advantage of the inherent volatility in the stock markets and not get scared of the same. Read on ...

The English translation is as under:

A newspaper article caught my attention recently. The headline said, “Stock market might remain volatile”.
The word “volatile” or “volatility” often evokes negative emotions and many associate the term with falling prices. However, the word itself means the prices can move in either direction – up and down. In that case, is this really news? Stock markets have always been volatile. As I have written n my book, “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”, “As long as decision-making is involved with different people having different motives, their opinions, decisions and actions themselves are going to move the financial markets in either direction.
Remove that from the market and voila, you don’t have a market at all. If all the individuals have the same information, same motives, same actions to perform, no trade can happen. For someone to buy, there should be someone to sell and vice versa.
The presence of a large number of people in the market, transacting on the basis of different motives and biases, makes the markets what they are.
Many get scared of volatility. Many stay away from the stock markets due to the inherent volatility of the markets. The fact is, normal markets are volatile and volatile markets are normal.
It is crucial to accept this fact.
The volatility is not bad. It simply exists. While, one can lose money on account of it, it gives profit opportunities for the traders and speculators; it also provides liquidity to the long-term investors, whenever they require. In the absence of volatility, the traders would not be interested in trading. The reduction in trading volume would kill the liquidity. This would have severe implications for long-term investing.
In such a case, it is upto one to decide whether to be scared of it or use it to one’s advantage.
So the question is: how can a small investor use volatility to one’s advantage?
There are a few proven strategies that one may adopt.
At the outset, let us understand that in stock markets, short-term price movements are more volatile than long-term movements. At the same time, the potential to offer higher-than-inflation is high if you hold your investments for long period (Assuming you hold a diversified portfolio of good quality stocks). With that in mind, stay away from equity markets, if you are going to need the money in the short-term. This will reduce the impact of volatility on your portfolio.
Second, if you are in your earning years, you should focus on saving some of your earnings regularly. Keep an eye on your expenses. The savings thus generated can be invested in the form of systematic investing (popularly known as SIP). This is a wonderful investment plan. On one hand, it allows one to invest one’s regular savings in a productive manner; it also makes the inherent stock market volatility to work for the investor. Since one is investing a fixed sum of money regularly, the units acquired each month are a function of the fund’s NAV.
An investor is allotted units based on the amount invested and the fund’s NAV. When someone invests Rs. 50,000 when the NAV of the scheme is Rs. 250, one gets 200 units (Rs. 50000 / Rs. 250 = 200). However, at the time of the next investment if the NAV has gone down to Rs. 200; the investor would be allotted (Rs. 50000 / Rs. 200) 200 units. As you can see, the investor got more units when the NAV was low and fewer when it was high. Thus, the average cost of purchase comes down. SIP makes the volatility work in the favour of the investor.
Next time you read about volatility, laugh it off. Volatility in stock markets is like the seasons, there would be summers and winters. You don’t wish them away. You learn to enjoy the beauty in the seasons. Same applies to investment markets. So don’t get scared of volatility. Simply set up an investment plan and stay put.
-        Amit Trivedi
The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.

1 comment:

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