In many ways, volatility could be defined as the price one pays in the short run for the returns they will get through large growth in the long run. There are several reasons why market volatility is a huge psychological test for traders and stock marketeers. With a constant stream of information constantly bombarding the investor, it is easy to be swayed by impulse or emotion to commit to irrational financial decisions.
On the opposite spectrum, high-risk-averse individuals may not consider the potential benefits of volatility in the slightest and miss out majorly on possible returns. Both such scenarios represent an irrational way of investing, which is characterized by a lack of discipline. In this article, we will look at how discipline can be maintained during market volatility.
Firstly, what do we mean by volatility? And what do we mean when we say that investors need to maintain discipline in the face of it? What does such discipline, in other words, entail? Volatility is essentially defined as an investment term that describes when a market experiences unpredictable or sharp price movements and deviates from its predicted value and returns.
If you have a very concentrated portfolio with a narrow selection in asset classes, you have a very big chance of being subject to such phenomena daily. However, volatility is inevitable in the investing world, even if there is a diversified portfolio. Several factors adversely affect how particular security would react; these factors could range from political to corporate factors to industrial shifts and supply shocks.
They could even result from something as minor as a message in a political speech or a tweet from a popular industrialist. The point here is that market volatility is an inevitable fact that an investor must encounter when confronted with the workings of the stock market.
What is required for the investor to establish a mindset and a discipline which overrides this short-term volatility and which looks towards long-term investing goals and financial ambitions? That is what volatility is and what a disciplined investment mindset is in the face of that volatility.
WHY DISCIPLINE IS IMPORTANT
Emotions can be a double-edged sword when it comes to investing. On the one hand, they are behind the initial spark and excitement you feel when you begin your investing journey. On the other hand, they can sabotage your short and long-term investing prospects in several ways. For instance:
- Fear of loss can prevent you from making any good trade, while you may also cut several winning trades short despite a detailed strategy in place for your investment portfolio.
- You may also allow the hype and trends of the media to disrupt your trading process, leading you to steer away from your trading strategy in the face of mild or short-term market fluctuations.
- Another way is that you may hold several positive assets for a long period, hoping to hit a fictional jackpot. This may lead you to hold those assets for much longer than necessary.
- There can be over-confidence within the investor due to past profits and positive trading. On the other hand, if the investor is under confident due to a series of bad trades, they may nervously hold on to their assets.
These are just some of how our instincts and basic impulses can influence our financial decision-making. All these and more can very heavily sabotage your investment career, and there is a crucial need to maintain discipline rooted in rationality in the face of market volatility.
HOW TO REMAIN DISCIPLINED
If the previous section of the article made you fearful of the investing world in general, the only thing you need to know is that you’re on the right track. Once you’ve realized that the stock market, especially market volatilities, are not a game but rather unexpected forces that test our convictions, we can look towards how we can remain disciplined in the face of them. In this section of the article, we will look at how you can remain disciplined in the face of market volatility.
DON’T LET THE HEADLINES SCARE YOU
We have all seen the different number of news headlines declaring cryptocurrency as ‘dead’ or talking about how Bitcoin has lost $100 Billion in just 24 hours. Such headlines are an inherent part of the media system, which maximizes profit through sensationalist articles that generate greater clicks.
However, these media headlines have a massive impact on the emotional impulse of an investor, who can easily be swayed into making a detrimental decision if they aren’t disciplined enough. It is, therefore, necessary for an investor to trust in their strategy and financial advisers and look towards long-term growth and gain. With every investment, the most sure-fire way to increase your chances of losses and anxiety is to act on your emotional impulse in response to media sensationalism.
As Warren Buffet himself said, the stock market is a game that results in wealth transferring from the impatient to the patient. This is clear when you look at the difference between the stock market returns and investor returns in the last 20 years. While the S&P returns were around 8.2% per year, these returns could dwindle to 4.5% if you did not trade in the top 10 trading days.
However, in general, you need to make sure that you kill the noise of sensationalist media outlets and do not prioritize those headlines over your sound reasoning and financial advice.
Consider the fact that according to Shalini Nagarajan’s article on the Insider, Bitcoin has been declared “dead” around 420 times by different media outlets, and it is possible to discern a pattern between authentic information and sensationalist views which simply exist to prey on uncertain economic situations which stimulate uncertain emotion responses.
This is the equivalent of not putting all your eggs in one basket and is a cornerstone of any prudent investment strategy. Tried and tested, diversification is a method that forms the base of disciplined investment strategy in the face of market volatility. It essentially means that your portfolio should be spread about several different asset classes and securities to lessen the risks of one having a downturn.
Many asset classes don’t correlate with one another or have different responses to similar economic situations. Hence, it is prudent for an investor to diversify their portfolio along those different assets to have a protected portfolio that does not react too much to market volatility that is targeted towards only specific securities, mainly equity and stock.
If you don’t diversify your investment portfolio and hence rely too much on a concentrated number of asset classes to stimulate capital appreciation, you may be at a greater risk of market volatility. Asset allocation is also an essential aspect of any diversification strategy that exists within a portfolio, and it is imperative that an individual investor diversify his holdings, keeping his individual interests in check.
In short, part of having a disciplined strategy in the face of volatility is having a diversified portfolio that reflects the long-term needs and requirements of the investor coupled with an integration of their risk tolerance and aversion.
This is definitely the way to go when it comes to being disciplined in the face of market volatility. In fact, long-term planning can be seen as the antithesis of acting in accordance with the short-term dictates of the volatile market. There are several reasons which can be used to support this claim.
However, the primary reason can be summed up in what has become known as ‘recency bias. This refers to the idea that due to short-term market volatility, investors may get an incorrect view of the future of the market due to their position within that volatile phase.
This triggers the emotional responses, which we have discussed in so much detail above, and which create detrimental effects for investors in the long run. What is necessary, then, is that the investors have a proper long-run goal in mind; this long-run goal strategy can adapt to the conditions of the volatile market, ensuring that you get the full advantage of the consequence of that market whilst also maintaining your initial long-term goals in place. There is, in short, discipline in having a rational long-term strategy for your investment portfolio in place.
RISK-TAKING AND OVERLEVERAGING
Risk is an inherent part of investing in the stock market. On the other hand, overleveraging is the artificial increase in risk that is brought about by borrowing money for the purpose of investment. Both these concepts need to be utilized properly in order to maintain a disciplined approach to the market volatility cycles. Risk is essentially the extent to which a particular investment can lead to financial loss, and it is increased during market downturns and volatile cycles.
If you have overleveraged, you’re trading by borrowing excessively, then greater downturns would lead to even greater losses, and so the investor would want to get out of the market quickly before the investment can go down in value even more. This is an example of irrational thinking that leads to detrimental consequences.
With the help of your financial advisor and your own financial knowledge, you need to determine the level of risk which you are willing to tolerate within a particular market, and you absolutely should not over leverage in markets unless you have an absolute necessity to do so. This argument, however, can also be flipped; we can argue, for instance, that over-leveraging is a major source of market volatility since it leads to greater upturns and downturns than are the market equilibrium.
What this essentially means to an outsider investor is that the volatile situation should eventually calm down, and a situation of balanced equilibrium would be created in the case of an over-leveraged market. This usually also works in favor of those investors who have over-leveraged since they can wait out for those volatilities and abnormal swings so that they can minimize their losses or look towards long-term growth strategies for those particular securities. This, too, then is a form of discipline in the face of volatile markets and should be considered as such.
MARKET DOWNTURNS ARE INEVITABLE
Downturns are an inevitable part of the investing world and should be embraced as such. Volatile situations present us with scenarios that test our courage and emotions in the face of a bullish and frightening market. However, you shouldn’t run away from that fear and ambivalence; but rather, you should accept it. It is only through that acceptance that you can then move with your financial dealings in a way that is sound, reasonable, and rational.
With all that said, we understand the various ways in which discipline can be managed in the face of an inevitable situation of market volatility. We can conclude that an obligatory aspect of any investing situation is that the individual investor makes mature and rational decisions every step of the way. Controlling mechanisms such as wealth firms and financial advisers can be used to ensure that rational thought is implemented behind every aspect of a financial decision, and this protects the individual investor from the unforgiving tides of the market.