Changes in inflation trends, plus industry and sector factors, can also influence the long-term stock market trends and volatility. For example, a major weather event in a key oil-producing area can trigger increased oil prices , which in turn spikes the price of oil-related stocks. A high VIX reading marks periods of higher stock market volatility, while low readings mark periods of lower volatility. The VIX is intended to be forward-looking , measuring the market's expected volatility over the next 30 days.
When volatility increases and markets panic, you can use options to take advantage of these extreme moves or to hedge your existing positions against severe losses.
This strategy is a simple but expensive one, so traders who want to reduce the cost of their long put position can either buy a further out-of-the-money put or can defray the cost of the long put position by adding a short put position at a lower price, a strategy known as a bear put spread.
The higher level of volatility that comes with bear markets can directly impact portfolios while adding stress to investors, as they watch the value of their portfolios plummet.
This often spurs investors to rebalance their portfolio weighting between stocks and bonds, by buying more stocks, as prices fall. In this way, market volatility offers a silver lining to investors, who capitalize on the situation. Crestmont Research. Fidelity Investments. Advanced Technical Analysis Concepts. Fundamental Analysis. Technical Analysis Basic Education.
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This strategy is based on the assumption that while there may be fluctuations in the market, it generally produces returns in the long-run.
While a highly volatile stock may be a more anxiety-producing choice for this kind of strategy, a small amount of volatility can actually mean greater profits. As the price fluctuates, it provides the opportunity for investors to buy stock in a solid company when the price is very low, and then wait for cumulative growth down the road. For short-term traders, volatility is even more crucial. Day traders work with changes that occur second-to-second, minute-to-minute. If there is no price change, there is no profit.
Swing traders work with a slightly longer time frame, usually days or weeks, but market volatility is still the cornerstone of their strategy. As price seesaws back and forth, short-term traders can use chart patterns and other technical indicators to help time the highs and lows. Using indicators such as Bollinger Bands , a relative strength index , volume, and established support and resistance levels, swing traders can pick out potential reversal points as price oscillates.
This means they can go long on the stock, or buy calls, as price nears a low and then ride the upswing to sell at or near the high. Similarly, predicting when a volatile stock is exhausting its current bullish momentum can mean shorting the stock, or selling puts , just as the downturn begins. These types of short-term trades may produce smaller profits individually, but a highly volatile stock can provide almost infinite opportunities to trade the swing.
Numerous lesser payoffs in a short period of time may well end up being more lucrative than one large cash-out after several years of waiting. The CBOE's volatility index, or the VIX , is a real-time market index that represents the market's expectation of day forward-looking volatility.
Volatility-based securities that track the VIX index were introduced the s, and have proved enormously popular with the trading community, for both hedging and directional plays.
In turn, the buying and selling of these instruments have had a significant impact on the functioning of the original index, which has been transformed from a lagging into a leading indicator. Major volatility funds include:. Trading these securities for short-term profits can be a frustrating experience because they contain a structural bias that forces a constant reset to decaying futures premiums. This contango can wipe out profits in volatile markets, causing the security to sharply underperform the underlying indicator.
As a result, these instruments are best utilized in longer term strategies as a hedging tool, or in combination with protective options plays. In times of high volatility, options are an incredibly valuable addition to any portfolio. Puts are options that give the holder the right to sell the underlying asset at a pre-determined price. If an investor is buying a put option to speculate on a move lower in the underlying asset, the investor is bearish and wants prices to fall.
On the other hand, the protective put is used to hedge an existing stock or a portfolio. When establishing a protective put, the investor wants prices to move higher, but is buying puts as a form of insurance should stocks fall instead.
If the market falls, the puts increase in value and offset losses from the portfolio. While puts gain value in a down market, all options, generally speaking, gain value when volatility increases. A long straddle combines both a call and a put option on the same underlying at the same strike price. The long straddle option strategy is a bet that the underlying asset will move significantly in price, either higher or lower.
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