With markets in volatile territory, traders are seeking new and diversified strategies to insulate losses and increase profitability
In a decade filled with uncertainty and surprises, few things have been more inscrutable than the financial markets. Traders have had to learn to navigate volatile markets, exacerbated by global economies being forced to embrace an imminent recession brought on by the coronavirus pandemic, the invasion of Ukraine, and several other geopolitical issues.
“The way it’s changed this year compared to the previous two years is that you could often buy into markets when they fell and still make money,” says David Jones, chief market strategist at Capital.com. “We’ve had booming markets – whether stock markets or commodity markets – since March or April 2020.”
Investors and traders have enjoyed rising markets in the last few years. In such a market, buying the dip was a popular and sometimes profitable strategy among traders, but in 2022 they are finding that is no longer the case. The broad US stock market, the S&P 500, is down 22% this year alone. “Markets are much more volatile,” says Jones. “Blindly buying the dip isn’t working this year.”
That isn’t a surprise to long-term investors, but is a rude wake-up call for anyone entering the markets in the last few years. “It’s important to be a lot more defensive now than previously,” he says.
However, there are ways investors can still find opportunities in the market, even in the extraordinary situation we now find ourselves, but it requires stepping away from widely used long-only trading strategies where you buy low and sell when prices rise.
Embracing the short sell
Three-quarters of all trades executed by Capital.com users in 2021 were long-only trades, meaning they bought shares in a company hoping the price would rise. It’s a general rule of thumb that continues today, even as markets everywhere are falling – more than half of the traders still take long positions. “It’s certainly something that’s ingrained into plenty of us as investors and traders,” says Jones. “You buy first and then sell higher up, hopefully.”
However, in an upside-down market, attitudes and approaches need to change. Short-selling – speculating on assets or securities that you predict could lose value – is one way to potentially make money in a challenging economy, where values and profits are being squeezed in every way. With short-selling, you sell a position in a company high, and look to buy when it’s lower in value. “But that’s quite a change in psyche for a lot of investors and traders,” says Jones.
There is also a belief by some that it’s unethical or unpatriotic to bet against companies – though that overlooks the dynamics of the market and the idea that every company can lose value as well as gain it. Short-selling was curbed in the United States in the aftermath of the 2008 financial crisis, but remains a valid and legal method of trading that investors may consider in fragile economic times like this. It does, of course, mean that investors lose money if a company performs better than forecasted, so the advice is to be careful with your cash.
Jones says: “With short-selling, it’s important to have risk controls in place, but you’re limiting your opportunities if you don’t look at the idea, particularly in the sort of markets we’ve had this year. It’s one strategy to look at if you thought markets were going to continue to slide from here in the months ahead.”
Using stop losses
When markets are in freefall, it’s important to apply the brakes. “Using stop losses is really important,” says Jones. In mid-May, Tesla was trading at around $900 a share. In mid-June, it was trading closer to $650. Traders who put measures in place to manage their risk were insulated from the full scale of that loss by putting in a stop loss, which is a notice to trading platforms that you want to sell if the value of a position drops below a certain value. “You can say: ‘I’m happy to buy at $900, but if it drops 10%, I want to come out’,” he adds.
Many retail traders, such as those who use platforms like Capital.com, aren’t fully aware of the range of options available to them, including stop losses. Jones advises deploying sensible risk control measures like the stop loss in order to insulate yourself from the challenges markets currently present to investors and traders alike.
Diversifying your portfolio
The challenging market is hitting everyone at present, but one way to try and slow the tide is by diversifying your investments. “It’s hard at the moment, because everything is falling,” says Jones. “But it’s better to spread the risk across different asset classes, companies and investments than to pursue profits from one single area that could quickly go south.”
Jones points to the price of oil: if a trader had rushed into oil in March this year when it surged after Russia invaded Ukraine, they would have lost around 30% of their investment. “Diversification is one option – and a very sensible option – when it comes to trading and investing,” he says. That includes investing in exchange traded funds (ETFs) and trading derivatives on a host of different markets including commodities, if investors think these will continue to rise in value. Gold, for example, continues to prove popular in challenging circumstances.
There is also another option he suggests, albeit one that seems unusual for traders and investors proactively looking for opportunities to profit. “You could do nothing,” he says, “if you thought this was all a little bit too crazy.” But thinking longer-term is crucial. “It can be very tempting, when markets are crazy, to be very short-term,” he says. “Don’t think because markets are crazy, and moving really quickly, that you have to act the same way.”
To learn more about short-selling and other retail trading strategies, visit capital.com/trading-explainers
Promoted by Capital.com