Thoughts on Volatility

Volatility is the enemy of the low risk trader and a friend to the gambler that likes action more than making money.  Mark Minervini

I went to Spain three weeks ago. I was fortunate to get there owing to Storm Dennis. We were one of the lucky flights that escaped out of Luton on that gale-force Saturday afternoon. It was the bumpiest take-off that I’ve ever experienced and the turbulence was no fun. Whilst we were delighted to take-off and reach our destination, the ride was one to forget.

The recent Market action over the last fortnight has blown me off course in the manner of Storm Dennis. I had been planning to write* about different sectors to buy, the best approach to picking quality shares and why size matters. That will all have to wait. At present, the live Market commentary is too enthralling to ignore.

I wrote a review piece last month on the Art of Execution by Lee Freeman-Shor. The first bad habit that the author identified was that of the Rabbits. Chief failing of that category of investor was freezing and failing to act when their shares dropped. The more successful investors would either sell or buy in such situations.

In times like these, many of us turn into rabbits. When confronted with days of red screens and we see the values of our portfolios shrink by thousands, it is normal for a sense of dread and panic to descend over us. Equally when we see a couple of days of blue screens with spiking increases, a looming feeling of regret replaces that feeling of dread (“if only I’d got in last Friday!”) Finally, that lingering feeling of (let’s admit it) mild smugness when the Market steeply spikes down into the red again.

We hate loss as human beings. We are wired to avoid it. It’s a more acute feeling than greed and can be debilitating. I’ve met a few people who have dabbled in shares, lost money and then given it up as being too risky. Part of the reason for this is that people jump into shares without a plan to reduce their risk. That risk can be reduced materially if you buy the right shares at the right time and have a clear exit plan.

In times of volatility (like we’ve experienced in the past fortnight) everything goes into hyper drive. You can be forced to make decisions much more quickly than normal. You don’t always think clearly and bad choices can be made.

Here are seven thoughts of mine on volatility:

1.       Until you turn positions into cash, any profits are not real. They remain as paper profits until the positions are sold. This itself can lead investors to snatch at profits. Really good money is only made by holding on to winning positions through ups and downs. So the winning investor has to have nerves of steel and sell when the downside risks materially outweigh the upside risks. You need to survive times of volatility.
2.       You need to be careful when jumping in to buy. It is so tempting to pile in any buy stock that you’ve been eying for a while and is suddenly at bargain prices. However, all bear markets start with Market panic. As has been oft quoted this week The market can remain irrational much longer than you can remain solvent. I wrote last week how I made some decent money after Brexit. That was a gamble I took as I believe that the fundamentals of the companies I bought were sound and would not be affected for too long. I fully admit that this could have backfired.
3.       Share prices never go up or down in a straight line. How many times have you chased a share, that keeps on going up and finally bought at the peak? Equally how many times have you bought a share that has dropped, only to see it drop by a further 5 or 10%? It’s almost like the Market is goading you as an investor. In truth you will almost never get into a share at the bottom and will very rarely get out at its peak. The key is to be patient. In times like these, it’s a good idea to wait until stability has returned before buying.
4.      If you see a good share that has been oversold and you cannot resist the temptation to buy when there is blood on the streets it isn’t always wrong to resist that temptation. Good money has always been made by buying oversold quality shares. However, don’t necessarily go “all in”. Buy a small position to start with and average up if it rises. Be willing to get out quickly if it drops.
5.       Trailing stop losses come into their own in times of Market volatility. During the falls of 24-28 February 2020, I saw about 60% of my portfolio converted into cash preserving my gains and leaving me to fight another day. It was reassuring that most of my portfolio was on auto-pilot and a lot of positions then went on to sink much lower than my exit price. I did miss something of the rebound on 2-4 March 2020, but I can live with that. I’ll be back in when certainty returns.
6.       Consider hedging strategies. You can short the indexes within an ISA if you manage it closely. My personal preference is to have a few index trackers following Government Gilts and Gold. Certainly my SIPP (which deploys these strategies) was less badly hit in the recent correction than my ISA (which was pure equities and cash).
7.      Don’t panic and sell everything. This is both expensive in terms of trading fees and you are likely to miss out on the rebound. Market timing is a mug’s game. Stick to a strategy of running trailing stop losses (perhaps widen them to up to 15-20% in times of real volatility) and let your portfolio run on auto-pilot. If it sells you out, then let it. You can always get back in when things calm down and you can reassess whether the investment case still stacks up.

Volatility is part and parcel of being a long term share investor. You have to survive it to allow you to reach your destination. I was fortunate with my flight to Spain. Had we booked with the other airline, we would not have had our holiday this Winter, as there was no chance of rebooking flights for several days. It was worth the volatility to make it the days of sunshine that we were able to enjoy.

Share investment is not all about easy gliding on summer days. You have to get through the wind and the rain. It is satisfying however to emerge on the other side less scathed than you otherwise might have been.

*This blog is published subject to this disclaimer.