Is Volatility A Four Letter Word?
The majority of investors see volatility as not only dangerous,
but something to be avoided at all costs. They equate volatility
with risk. But volatility and risk are two entirely different
To market timers, volatility is the precursor to profits. To have no volatility
would be to have no profits.
In addition, to single out one period of time when volatility is causing losses,
is to miss the big picture which shows that, over time, volatility is the main
ingredient to making huge profits.
Consider this example of volatility.
Let's say that you enter the market with a starting sum of $10,000 and the
market enters a substantial uptrend and you are ahead by 30%. Your original
$10,000 is now worth $13,000.
Then the market reverses and you drop down to $12,500. Is this a reason to
If the trend is still intact, it is not.
As trend followers, if we are still in the same trend,
we may very well now move up to $15,000 or higher in short
order. This is what trend following is all about... riding
a trend to the end, not exiting at the first retracement.
But many traders would be devastated at dropping from $13,000 down to $12,500.
Too many market timers get upset for the wrong reasons. There is no way to
control how profits are made. We can only ride the trends, as far as they will
go, when they occur.
Market timers who follow trends have greater upside volatility than downside
volatility because they exit losing trades quickly with small losses and stay
with winning trades until the profitable trend ends.
thing to remember is that we stay with profitable
trends, often for a long period of time."
The important thing to remember is that we stay with profitable
trends, often for a long period of time.
When we start a profitable trend, we often make our profits in quick bursts
of "volatility." That is why volatility is our friend, not our enemy.
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We generate strong profits by correctly determining
profitable trends and minimizing the cost of failed trends
with quick exits.
When we have periods of sideways, non-trending markets, where there is no long
term trend, we do not allow losses to accumulate.
When the market does break out into its next big trend, whether it be to the
upside or to the downside, that is when we make our profits. And we do not exit
the trend early. Exiting to protect profits assumes you "know" ahead of time
when a trend will end.
No one knows ahead of time.
So we must allow the trend to complete before we exit.
That means we will catch the "majority" of the trend,
when it occurs, as profits.
Huge Volatility Equals Huge
Invariably, the best profits come with the highest volatility.
That means as trend followers, we must react to changes
in trends, stick to our guns and make all the trades.
We may have some small losses when trends fail, but when the market finally
breaks out (or breaks down), we make huge gains by riding the new trend as
long as it lasts, to the upside in our bullish only strategies, and in both
directions (long and short) in our more aggressive strategies.
mistake the volatility, used by trend timing
strategies to make profits, as negative. But
the opposite is true."
By following a set of rules, we do not have to agonize over protecting an open
profit, nor do we need to constantly change our strategies to find ways to
The question is not how to reduce volatility, but how to manage it with proper
risk management. This means not allowing failed trends to accumulate losses,
and not exiting profitable trends early.
Skeptics mistake volatility, used by trend timing strategies
to make profits, as negative. But the opposite is true.
There is a big difference between volatility and risk.
Many investors see them as the same. But embracing volatility while controlling
risk (cutting losses) is the key to successful trend timing.
We may see periods when profits are nonexistent for months or more. We may
have several failed trends that generate small losses. But successful trend
timers see these periods as the base for the next huge profitable trend.
In fact, we know extremely successful market timers who get excited when they
see periods of sideways, non-trending markets as they know what comes next.
The next huge trend is right around the corner! The longer the sideways market,
the more profitable is the coming trend.
Unfortunately, many who do not understand the logic of market timing by trading
trends are not around when the big trends occur. They are sitting at their
computers trying to find a new strategy that will guarantee gains while never
This is an impossible goal.
Losses are inevitable. But so are the gains that are
achieved by trend following strategies, taking the trades,
minimizing the losses when trades (trends) fail, and
riding the inevitable big trends for all they are worth
when we get them.
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Disclaimer: The financial markets are risky. Investing is
risky. Past performance does not guarantee future performance.
The foregoing has been prepared solely for informational
purposes and is not a solicitation, or an offer to buy or
sell any security. Opinions are based on historical research
and data believed reliable, but there is no guarantee that
future results will be profitable.