For novice financial market traders, one of the biggest mysteries is how experienced investors are able to see opportunities in volatile markets.
This is particularly evident in entities such as the forex market, where prices can shift markedly in a relatively short period of time and present both challenges and opportunity in equal measure to investors from across the globe.
We’ll explore this further in the post below, while asking why volatility is important in investment and how investors can prospect opportunities in a changeable and fast-paced market.
Why is Volatility Important in Investment?
We touched earlier on the forex market, which offers a corporeal example of how volatility both underpins a financial entity and creates opportunities to increase profits.
This was particularly evident during 2020, when the coronavirus pandemic promoted countries to cap base interest rates as part of comprehensive quantitative easing measures (reducing the value of currency in the process).
In the forex market, assets and currency pairings can be traded as derivatives, which allows you to invest without assuming ownership of the underlying financial instruments.
This means that you can profit by speculating on both depreciating and appreciating price movements, creating a scenario where increased volatility offers more profit potential.
Even in more traditional entities such as the stock market, there’s an inherent relationship between performance and volatility. This can help investors to understand the market and make more informed decisions in real-time, regardless of their outlook or underlying trading strategy.
More specifically, it has been found that higher stock market volatility translates into an increased probability of a declining marketplace, while lower volatility typically is indicative of a growth market.
So, investors can use this data to align their portfolios and optimise returns over time, while understanding the impact of volatility on a vast and highly capitalised marketplace.
How can Investors Prospect Opportunities in Volatile Markets?
For most investors, volatility is indicative of increased risk, prompting them to seek flight and invest in more secure and safe-haven stores of wealth such as gold or the Japanese yen.
However, it’s far harder to prospect and pursue opportunities in a volatile marketplace, especially in the aforementioned forex market and similar instances such as cryptocurrencies, mutual funds and South African commodities.
South Africa is widely considered to be a commodity-driven economy, which means that its growth is heavily reliant on the sale and export of industrial materials, precious metals and similar asset classes. This type of economy can be naturally volatile, thanks to variable factors such as supply and demand and its susceptibility to socio-economic challenges such as the coronavirus.
So, when attempting to invest in a volatile currency such as the South African rand through your forex broker, you’ll need to study relevant news sources in detail and monitor the wider economic trends in order to time your trades effectively.
When trading currencies in general, it’s also a sensible move to target a period of particular volatility in order to optimise the profitability of short-term positions. This is why so many choose to trade during the crossover between different geographical sessions, which trigger increased trading volumes and higher levels of volatility.
In general terms, understanding market movements in detail and effectively pre-empting these is crucial if you’re to profit from volatility, otherwise you’ll risk incurring losses that may be disproportionate to your initial deposit.