Volatile times can be cause for concern among traders, especially novices who might be tempted to pull out of the market altogether and wait on the sidelines until it appears safe to jump back in. However, there are alternative strategies that can help to counter the volatility of markets.
Statistical measures from volatility can represent the tendency of a market or security to rise or fall sharply within a minuscule amount of time. It is typically measured by the standard deviation of the return on investment. When prices are tightly clustered together, the standard deviation is small. Meanwhile, when prices are widely spread apart, the standard deviation is large.
When markets are volatile, it is usually characterized by wide price fluctuations and heavy trading. They often result from an imbalance of trade orders in one direction such as all buys and no sells. There are many causes of volatile markets, but one of the most influential is the economic climate.
Volatility in markets
For example, some stocks in the stock market can be a highly volatile place with all-round swings in its performance annually, quarterly, and even daily. The Dow Jones Industrial Average isn’t exactly cushioned from any market blow as well, especially from the recent economic bump. Although this unpredictability can demonstrate significant investment risks, it can also be a way to generate solid returns for astute traders. There are still opportunities even when markets are rough, crash, or surge.
When markets are volatile, deciding where to trade can be complicated, and many factors need to be considered in order to make the best choice. The most important element may be the trader’s or risk tolerance, trading style, and instrument.
What to trade: forex, commodities, or cryptocurrencies?
Foreign exchange (forex), also known as currency trading, is a global market for trading the currencies of the world. Commodities market, on the other hand, trades in the primary economic sector such as raw materials. Crypto trading is the buying and selling of cryptocurrencies, which highly resembles forex trading.
While all these assets are viable instruments for trade or investment, not all can weather volatile markets. Forex and commodities, for example, primarily depend on global politics or economics–both may fall sharply in value especially during global economic slowdowns. Unlike both assets, cryptocurrency does not heavily rely on a particular economy or central authority. The market pricing is determined mainly through supply and demand.
When trading these assets on volatile markets, traders should keep in mind on what strategy they should take advantage of. Two techniques that they can benefit from include hedging and arbitraging. While hedging is one of the oldest tricks in the book, arbitrage can be seen as an alternative trading strategy that can take advantage of certain market inefficiencies.
Can hedging maximize profitability in volatile markets?
Hedging is not meant to search for risk-free trades. Instead, it is an attempt to control any known risks while trading. Traders use a combination of instruments and derivatives, such as options contracts, forward contracts, swaps, and other derivatives to purchase opposing positions in the market. By betting on both opposing movements, traders can ensure a net-zero or positive position in terms of risk. In addition, while models do exist to determine ways to hedge risk, there can still be uncertainty and speculation involved, for instance in forex or cryptocurrency exchange. “Hedging allows firms to minimize the uncertainty associated with unexpected changes in the exchange rate. The decision on whether or not to hedge an open position is a speculative decision, as it depends on the expected spot rate when the payment or transaction settlement becomes due,” write Ahmad Bash et al in a study published in the International Research Journal on Finance and Economics.
This seems like a straightforward strategy for volatile markets, but profitability is in question. A reduction in risk is a reduction in potential profits. Thus, hedging is a strategy that won’t increase profitability, but rather a technique that can reduce potential risks. While technology has played a major part in innovating some trading strategies, hedging is still on the way to taking full advantage of it.
How arbitrage can ensure profitability even through volatile times
Arbitrage takes advantage of asset mispricing or price inefficiencies across different markets. “There are many instances of pricing discrepancies in exchanges and products mainly driven by differing exchange rates, demand, and locale. This means that with a good consistent system, one could buy an asset from a place and sell it in another place for a profit,” says Tony Jackson, Chief Executive Officer at Jubilee Ace, a technology company that provides an algorithmic trading platform for cryptocurrency and other asset classes.
By using automated algorithmic trading, traders can take advantage of these contingencies and maximize asset growth. “I would say arbitrage benefits the most when there is high volatility. Speed is the key when it comes to arbitrage, as opportunities are often available for a short period of time–thus technology will play a big part,” Jackson adds.
This strategy can especially be applied to volatile markets such as cryptocurrency as there are hundreds of exchanges in existence, trading at least 18,000 markets. Automated trading platforms can also service other markets such as forex, commodities, and sports arbitrage, among others.
Growing portfolio with alternative strategies
In these trying times, market volatility should not scare away traders from finding ways of growing their assets. One can learn through financial, technical education and experience. In terms of the trading strategy, and automation can help in ensuring growth while minimizing the risks.
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