Playing the game of “Where’s Voldo”to save your assets
Market volatility is rising sharply following a long layoff. Like the kids’ game ‘‘Where’s Waldo,’’ you might have been wondering where the wild swings of the stock market have been. After all, 2019 was a low-volatility, upwardly-mobile year for stock markets around the globe. Until the last week or so, you could have been excused for wondering, ‘‘Where’s Voldo?’’ Look no further Voldo (volatility) has returned.
But is Voldo moving in with us, or he just in town for a short visit? We never know, but it is critical for you to understand the implications, either way. This article aims to help you understand what risks and opportunities spring up when the market suddenly gets volatile.
What is stock market volatility?
But first, let’s explain what ‘‘volatility’’ is. In layman’s terms, it describes the degree to which stock prices are bobbing up and down over a period of time. To quantify this, the ‘‘volatility index,’’ nicknamed VIX, was created in 1993 and measures volatility every minute of every day that the stock market is open. Historically, readings have been as low as 9 during complacent periods, and have spiked as high as the 40-60 range during emotional periods such as 9/11 and the Enron fiasco. During the past few years, the VIX has spent nearly all of its time between 11 and 16, with a couple of spikes above 20.
Okay, so that’s the quant-geek definition of volatility. In English, what does it mean? Low volatility can be interpreted as investors being complacent, not worried. High volatility implies an element of fear in investors’ current attitudes. When volatile markets come around, it is not the actual VIX level that is most important.
Risk-management during volatile times
The key is twofold: first understand how the rules of risk management change when volatility kicks up. Then, once your “assets” are covered, you can move on to the cool part: seeking to exploit volatility for profit.
Most folks fear volatile markets. Hedged investors welcome them. After all, if you have the tools and knowledge to capitalize when others are flailing, it’s a nice way to help yourself sleep at night. And, if you are in the financial planning business professionally, having that ability is a way to attract positive attention.
Risk management: a lost art?
Many investors have no idea of how to practice risk management, much less how to exploit rough markets.
There are five primary elements of risk management:
- Having a “culture” of continuously accounting for what will happen if your optimistic expectations turn out to be completely wrong
- Understanding how to use the “tools of the trade” of hedging your portfolio. Inverse ETFs, options, cash and equivalent securities, and assets not correlated to the broad movement of the stock market.
- Thinking in multiple time frames. That is, realizing that some investments in your portfolio are OK to leave in place, while others are fungible. A combination of long-term and tactical investing helps you to focus on the parts of your portfolio that need the most attention in volatile times. And, it prevents you from falling prey to the trap of full-scale, outright market-timing.
- Learning how to take your biggest risks with small amounts of money. This is one of the things I like about owning put and call options as part of a larger portfolio. They allow you to commit a much smaller amount of capital to attempt to profit from an idea, yet potentially earn the same or more profit than if you had risked more capital. Note that I am not talking about the so-called “covered call writing” approach. I am referring to buying options as a surrogate for taking exposure through stocks, ETFs, and mutual funds.
- Being supremely humble and devoid of greed at all times. After all, the enemy of great risk management is a big ego. Let others show off during volatile times. If they get away with it, good for them. But you stay grounded, humble, and focused on the priority of balancing reward and risk properly at all times.
While many investors have forgotten that risk-management matters, history shows us that it is effective preservation of capital during down cycles that truly drives successful long-term investment outcomes. Voldo’s here. Keep an eye on him.
Comments provided are informational only, not individual investment advice or recommendations. Sungarden provides Advisory Services through Dynamic Wealth Advisors