Investing in the stock market makes you feel like riding on a rollercoaster. It does take a lot of time for people to learn about this and feel comfortable with the investment. It is common because of the market’s ups and downs. There is a very close relationship between recession and the stock market.
About 90% of people unaware of trading or doing it for the first time lose their money. Stock markets are known for their turbulent ups and downs. While some volatility is normal, major swings can understandably rattle investors. Knee-jerk reactions to market fluctuations are often counterproductive, though.
But if you follow smart practices for reacting to volatility, you can avoid emotional decision-making and remain focused on long-term goals.
Understanding Market Volatility
Volatility refers to the frequency and degree of price variations in securities or markets. Several factors drive volatility.
- Economic news like jobs reports or Fed decisions
- Corporate earnings surprises
- Geopolitical events
- Investor fear and greed
- Lack of liquidity during big sell-offs
Large price swings can happen intraday, daily, monthly, or over longer periods. Periods of abnormally high volatility are often sparked by major events causing uncertainty.
For example, the CBOE Volatility Index (VIX), which measures S&P 500 volatility, spiked to over 80 in March 2020 at the onset of the COVID-19 pandemic. Its historical average is around 20.
Market volatility itself is neither good nor bad. However, investors require mental discipline. Having a strategy for responding to ups and downs is vital.
Dos- Adopt These Best Practices
While ups and downs are inevitable, preparation and discipline can help you respond effectively to market volatility.
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Remember the Time Horizon
Focus on the long-term goals 5-10+ years out, and do not get sidetracked by short-term noise. It will be better to have a multi-year investment plan. It is crucial to keep your time horizon in mind while reacting to market fluctuations.
If you have a long-term horizon, short-term market volatility may be less concerning, as you have more time to ride out fluctuations and benefit from potential market upswings. Conversely, if your time horizon is short-term, you may need to adjust your investment strategy to protect against market downturns and preserve capital.
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Maintain a Diversified Asset Mix
Diversification reduces overexposure to volatility in one asset class. Rebalance periodically back to the target allocation. Diversification is a cornerstone of prudent investing, especially during market volatility.
By expanding your investments across different sectors, asset classes, and geographic regions, you can reduce the impact of volatility on your portfolio. A diversified portfolio can help you mitigate losses in one area while potentially benefiting from gains in others, providing a more stable foundation for long-term growth.
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Review Your Financial Plan
Regularly reviewing your financial plan is essential, particularly in market uncertainty. Assess whether the strategies for your investment align with your financial goals, time horizon, and risk tolerance. Consider whether any adjustments or rebalancing are needed to stay on track.
If you consult with a financial advisor, you can provide valuable insight & guidance to ensure your financial plan remains robust and adaptable to changing market conditions.
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Learn to Expect Volatility
Volatility is essential to investing in the stock market, and learning to expect it can help you maintain perspective during turbulent times. Recognize that market ups and downs are normal and often present opportunities for long-term investors.
When you expect volatility, you can avoid reacting impulsively to short-term market movements and focus on your long-term investment objectives.
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Focus on Fundamentals
Getting caught up in market noise and speculation during heightened volatility is easy. Instead, focus on the fundamentals of the companies you’ve invested in.
Evaluate their financial health, competitive positioning, and long-term growth prospects. Sound fundamentals can provide a solid foundation for weathering market turbulence.
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Stick to a Long-term Investment Plan
Develop a well-thought-out investment plan tailored to your financial goals, risk tolerance, and time horizon.
During periods of volatility, resist the urge to deviate from the plan based on short-term market movements. Stay focused on your long-term objectives and stick to your investment strategy.
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Remain Calm and Patient
Avoid emotional reactivity during the stock market recession. Volatility passes eventually. Consistency and discipline pay dividends over time. Making costly errors might result from impulsive reactions to changes in the market.
Instead, maintain a calm demeanor and keep the bigger picture in mind.
Remember that market downturns are often temporary and part of the natural ebb and flow of the market.
Don’ts- Avoid These Common Mistakes
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Panic Selling
One of investors’ most common mistakes during market downturns is panic selling.
Selling investments in a panic can lock in losses and undermine long-term financial goals. One should not make impulsive decisions based on fear or short-term market movements.
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Stop Loss Overuse
While stop losses can protect against severe losses, they realize volatility-induced losses. Consider whether wide stops up to 10-15% are vital.
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Overtrading
Volatility tempts some investors to trade excessively. But this raises costs and taxes while rarely adding value over the long term.
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Constantly Watching Prices
Monitoring daily price fluctuations can be counterproductive and does not change long-term prospects.
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Portfolio Overhauls
Major portfolio changes in response to short-term volatility are usually ill-advised. Trust your original investment plans. Avoid overleveraging your investments, particularly during uncertain times.
High debt or margin trading levels can increase your exposure to market risk and potentially lead to financial distress.
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Resist the Urge to Chase Performance
FOMO (fear of missing out) can tempt investors to chase after hot stocks or sectors that have recently performed well. However, chasing performance can be a risky strategy, particularly during periods of heightened volatility.
Instead, focus on the long-term fundamentals of your investments rather than short-term market trends.
Volatility Survival Toolkit
Having the right knowledge, resources, and habits will help you endure volatility:
- Understand market history– Study past trends, cycles, and crashes for perspective.
- Tune out short-term noise– Break the habit of constantly monitoring daily price swings.
- Focus on value, not price– Make buys based on careful valuation analysis rather than following momentum.
- Keep cash reserves– Maintain funds to deploy into sell-offs without having to sell anything else.
- Have a financial plan– A thoughtfully created plan provides confidence and perspective during volatile periods.
- Diversify globally– Allocations beyond just U.S. stocks can smooth out volatility.
- Hedge with certain assets– Include some assets with non-correlated or inverse market activity to offset portfolio declines during sell-offs.
- Invest regularly– Systematic contributions help dollar cost average into the market at various prices rather than timing entry points.
Conclusion
Market volatility can be unsettling, but having the right mindset and actions will prevent you from making irrational moves. Avoid extremes, focus on fundamentals, maintain perspective, and stick to a sound long-term investment plan. With patience and discipline, periods of increased volatility will become more manageable.
Peter Williams, a financial writer with over five years of experience, specializes in covering stock market movements, bond markets, commodities, and macroeconomic trends.
