Does risk equate with volatility? This phrase is often put in a tone of stating a fact than asking a question. Of the many threatening ways of thinking about investment it remains at the top. Either way, financial markets be volatile or stable are only for ambitious, vigilant and disciplined traders. Generally people tend to perceive volatility synonymous to risk; volatility in markets is considered risky as it indicates irregularity of an investment. The price of financial instrument oscillates and traders may not be able to take leverage out of it, subsequently, view investment as risky. Nevertheless, it’s quite opposite to this misleading notion.
In financial theory, volatility, leverage, and liquidity are the ideal and most lucrative combination – for seasoned traders it seems all stars are aligned. Volatility is huge back and forth movements of markets in either direction. When there is a wind of uncertainty the markets open windows of opportunities and let the buyers and sellers breeze in – boosting liquidity one way or other. Volatility is indeed an opportunity – the higher the volatility, the riskier the financial instrument, means higher potential rewards. Owing to the fact that traders experience the pain of loss more intensely than the bliss of reward, tend to paint irrationally uncertain proposition of financial markets. Financial markets give option to measure twice and cut once.
The rule of thumb is to identify and manage the risk that revolves around variance and volume of the financial instrument in volatile and risky markets i.e. P/L = ΔV. It refers, if markets are volatile yet liquid, one can always control its loss by reducing the delta through a quick exit. Identically, on the other hand, one will make hay while the sun shines with leveraged position.
Seemingly, time is giving an impression of being shrinking, whereas things are gaining momentum. A lot is happening on the spur of moment. Investment has now trimmed to trading, trading shortened to scalping, and in contrast scalping has now reduced to High Frequency Algorithmic Trading. Bearing this in mind, financial markets are becoming paradigm of changes due to the vast irregular switching in time-trends. As financial markets are subject to economic indicators, regulatory bodies, market sentiments, and political risks, therefore traders ought to consider in advance the risks that may have repercussions on their capital. Risk-capital is bait which can catch many fish and interestingly bait is still safe when markets are volatile but observing discipline in trading is a key for optimal outcome. Nonetheless, some traders cook the sauce before catching a fish, means they become frenzied with markets oscillation and pull out all stops for haphazard exit.
In the most recent scenario the phrase ‘Trend is your friend’ was capitalized in its true spirits in the light of Volatility and Risk Management. Traders made huge fortunes by entering in to long positions in US stocks despite overall market volatility. The amazing returns from 2020 in US stocks made it seems almost desirous to expect further advances for three main stanchions of Wall Street by the end of 2021. As seeing is believing, most impressive was the NASDAQ’s gains that inched 44% higher, as investors flocked to the tech-heavy index. Now imagine, a leveraged position of 1:40 against aforementioned gains could amplify your gains in leaps and bounds.
Not to mince words, fundamentals and technical driven markets don’t come with their disclaimer every time. Proper risk management strategy, market analytics, comprehensive training, understanding of algorithm can give you flavors of heaven of financial markets. Volatility is inherent to financial markets; it is like a wild horse it is up to traders to control it through vigilance and discipline.
