Volatility, not anxiety, should become a source of wisdom.
The up and down essence of the stock market is volatility. As stocks always do move up or down, your trading plan must be prepared each and every day to deal with volatility. From high volatility to low volatility, assets trend differently. Although volatility must be compensated for by a trader when it comes to position sizing and distance to stop losses, it should not be treated as detrimental to an opportunity. To have trends that traders can make money on, we need markets to rise or fall and not remain flat.
While many investors appreciate volatility and require it to transact in their timeframe, it poses as many dangers as opportunities. You will make a lot of money if you are on the right side of volatility while being on the losing end can cost a fortune.
Top Volatility Hazards:
- Volatility can cause a stop loss to trigger, only for the price to go back in favor of your old position
- If you trade on the long and short side of the market, being on the wrong side of the market twice as it swings rapidly in both directions, can double the losses quickly.
- Losses can be higher than usual and, even if using normal position size criteria, movements can be several times greater than expected based on past fluctuations.
- Volatility could overwhelm traders emotionally and create even more pressure for market participants that they avoid trading or investing whatsoever.
- Volatile market movements may lead traders to engage in a strategy across time frames and processes that they normally do not trade and don’t have an edge trading.
A better option than to hate volatility is to control your trading against volatility. Risk mitigation is a critical pillar in the preservation of capital.
Volatility, not anxiety, should become a source of wisdom. During the most unpredictable markets, the greatest trends can appear. During periods of instability and at market tipping points, volatility grows. When a trend is formed, volatility will decrease.
Volatility isn’t on the downside only. Stocks can change by moving both up and down in a large price range. One way to think about upside uncertainty is as such: imagine a market that is rising. At $100, you enter, and the price rises to $150. Then the price drops to $125. Is this extremely bad? Not, likely. Since the price could then suddenly jump to $175 after going from $100 to $150 and then slipping down to $125. This is volatility in motion to the upside. If a stock is always producing higher highs or lower lows as it bounces within a longer-term cycle, volatility may be a good thing.
Trend traders have higher upside volatility and lower downside volatility than conventional stock indices such as the S&P 500 since, with predetermined stop losses, they exit losing positions quickly. As they constantly aim to see how their entrance into a market pans out into a larger macro trend, they deal with several minor losses. By cutting a trade that has advanced against a trend traders’ stop-loss limit, they minimize the amount of harm that volatility will do to their portfolios.
Tips on Trend Trading:
- Volatility will aid you in establishing the size of your positions and the placement of stop losses.
- Average True Range (ATR) and the VIX are a few powerful volatility metrics.
- In a market, volatility is a metric of motion and risk is the sum of money you will lose when a trend goes against you.
- In a winning trade, you have to lose some of the unrealized profits to be able to gain greater profits in a longer-term pattern.
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