We’ve seen an unprecedented move in equities, as stock market volatility skyrockets in the first quarter of 2020. The coronavirus-induced increase in volatility has led to one of the most aggressive bear markets we’ve ever seen in the S&P 500.
Put another way, the Dow Jones went from an all-time high to a bear market in just 19 trading sessions. The previous fastest took 36 trading sessions, followed by 37, 38 and 39 sessions for the Great Depression, Great Recession and Black Monday. That helps put this move into perspective.
Amid that move, we’ve seen the VIX soar, topping $85 so far at its high (as shown below).
Granted, this spike in stock market volatility has been intense, but it won’t be the last time we see it. Knowing how to trade when volatility rises is key to survival — both as an investor and a trader. If the move caught you flat-footed and off-guard, this is a learning lesson for the next time.
Here are some tips.
Reduce Your Position Size
This one is a biggie, and it doesn’t matter if you’re an investor or a trader at this point. When volatility ramps up, reasoning goes down. Stocks can jump or dive significantly on no news and without reason.
If you’re trying to trade normal size on this now extra-wide trading range, you’ll get chopped right up. That’s why we need to reduce our trading size to allow for these outsized moves. Because remember, this is all about managing our risk.
For example, say our risk is $100 per trade in a normal-volatility market and we trade a 100-share position. In essence, we are risking $1 a share. However, when stock market volatility is running rampant, we may instead opt for 50 shares, 33 shares or 25 shares, allowing that loss-per-share to climb up to the $2 to $4 range, without risking more than $100.
This allows us to still make our trades without subjecting ourselves to outsized risks. Failure to cut down your trading size and you’ll learn very quickly how painful a high-volatility environment can be.
Investing? Same Thing
Just as traders should cut down their size, so too should investors. I have a plan for market sell-offs that makes dealing with them easier on the mind. When setting downside targets or looking for your buy price, consider a small size if considerable downside risk still looms.
Obviously it depends if the S&P 500 is down 10% or 40% at that point. But for those that set downside limit orders, you must consider the possibility that the stock goes through that price and heads even lower.
As a result, consider smaller size, so you can again nibble on the stock should it continue lower. It’s one thing if a bottom has been established in the market. When there’s not, buying too much, too early can be a painful experience.
Zoom in or Zoom Out
This one is important, and knowing which to do depends on your timeframe. If you are a longer-term investor, focusing on the hourly or daily moves is not likely to help your emotional state.
Instead, zoom out and focus on the bigger picture. Instead of a daily chart, look at a weekly. The monthly chart often goes unused by many, but can be very helpful in seeing the really big picture. It’s one thing I love about TradingView, as I can use any timeframe that I please.
The opposite of zooming out is zooming in. For those that are used to using the daily charts, consider using shorter timeframes. That may be a 60- or 65-minute chart, or possibly a 10- or 15-minute chart. It might be a 2-minute chart.
When volatility ramps up, typical swing trading becomes almost impossible because the market is gapping up or down by 3%, 4%, 5% or more. If you’re on the right side of it, it can be a windfall of short-term profit. Land on the wrong side though and you’ll be taking a painful body blow.
We’re trying to avoid the body blows and knockout punches. By zooming in and reducing our position size, we can practice our 5 D’s of Dodgeball, ducking and dipping in a day trading environment. You can trade the same patterns you trade on the daily on the 10-minute charts — be it breakouts, ranges and trends. Of course, for smaller profit.
But…
Cash Is King (and a Position!)
Remember, cash is king. A lot of people will talk a big game when stock market volatility is very high. How they banked 1,000% on put options and how they’re killing it on the trading front.
It’s true that higher volatility can make for some great intraday day-trading environments. But if you lack experience in high-volatility environments or do not have the discipline to cut losses when the trade parameters change, you may not be ready for the situation.
There’s no shame in that, either. Talk to anyone who’s been in the game a while and they will tell you just how difficult these environments are. Anyone who tells you differently isn’t worth taking seriously.
“Cash is king” is a saying for a reason. And doing nothing is absolutely okay. When in doubt, stay out. You can be long or short this market, but you can also sit on your hands and wait for a better trading environment.
You do not have to:
- Day trade if volatility is too high
- Trade for several days or weeks
- Feel like you are missing out
The market will always be here. It took me a while to really grasp that fact. It’s here when I get back from vacation and it’s here when I am ready to trade. Being in cash keeps your emotional and mental capital healthy too, helping put you in the right mindset.
Patience can be a tough, but often a rewarding endeavor.
Bottom Line on Rising Stock Market Volatility
So remember, when stock market volatility is ramping higher, reduce your trading size and zoom in or zoom out depending on your timeframe. Also remember that cash (being neutral) is a position and eventually, a trend will begin to form once again, either higher or lower.
Don’t be afraid to sit in that batter’s box and watch pitch after pitch go by. Screw the crazy curveballs and wild pitches. We want a nice fat one down the middle, and we’re going to wait for it, no matter how long it takes.